Currency board definition
A currency board is a central issuer of notes and coins for a given country’s currency. It is differentiated from a central bank in that it does not make loans nor set monetary policy; typically the currency is tied or pegged to a foreign anchor currency, most often the U.S. dollar, British pound, or the Euro. Because the currency board ensures that the currency is kept closely aligned with the anchor currency, interest rates and inflation tend to closely mirror the conditions of the foreign economy to which the domestic currency is tied. Currency board arrangements are based on a fixed rate of exchange. This provides a level of security for the domestic currency, but creates a financial situation closely tied to the conditions present in the anchor currency country at any given time. Currencies were originally tied to the value of gold or silver; this was the original form of currency board in existence.
Activities of the currency board
Because domestic currency is pegged to a foreign currency, the currency board is responsible for maintaining sufficient reserves of the anchor currency to cover the amount of domestic currency in circulation. These reserves usually consist of bonds and securities in sufficient quantity to cover the currency in circulation, with a small additional amount as a security margin. In these systems, the board also acts as a currency exchange board, converting domestic money into the anchor currency and back again.
Currency board systems
Some currency boards are paired with a central bank, which serves as the lender of last resort for commercial banks, guaranteeing their deposits and setting monetary policy by releasing varying amounts of currency to circulate through the system. However, the traditional form of currency boards does not allow for this level of monetary policy; instead, the financial stability of the system is directly tied to the anchor currency. In some cases, this produces a more reliable domestic currency, but can produce instability if the anchor currency develops difficulties or falls prey to inflationary influences.
Present-day currency board arrangements
The primary currency board system in use today is that of Hong Kong; the Hong Kong Monetary Authority oversees the arrangement, which uses the U.S. dollar as its anchor currency. Other countries utilizing a currency board arrangement include Bulgaria, Estonia, and Lithuania. Argentina abandoned its currency board system in 2002 due to a severe recession; some analysts believe that the failure of Argentina’s currency board was the result of irregularities in how it was administered rather than a failure of the system itself.