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Concept
Currency board
Summary
In public finance, a currency board is a monetary authority which is required to maintain a fixed exchange rate with a foreign currency. This policy objective requires the conventional objectives of a central bank to be subordinated to the exchange rate target. In colonial administration, currency boards were popular because of the advantages of printing appropriate denominations for local conditions, and it also benefited the colony with the seigniorage revenue. However, after World War II many independent countries preferred to have central banks and independent currencies.
Although a currency board is a common (and simple) way of maintaining a fixed exchange rate, it is not the only way. Countries often keep exchange rates within a narrow band by regulating balance of payments through various capital controls, or though international agreements, among other methods. Thus, a rough peg may be maintained without a currency board.
The main qualities of an orthodox currency board are:
A currency board's foreign currency reserves must be sufficient to ensure that all holders of its notes and coins (and all bank creditors of a Reserve Account at the currency board) can convert them into the reserve currency (usually 110–115% of the monetary base M0).
A currency board maintains absolute, unlimited convertibility between its notes and coins and the currency against which they are pegged (the anchor currency), at a fixed rate of exchange, with no restrictions on current-account or capital-account transactions.
A currency board only earns profit from interest on foreign reserves (less the expense of note-issuing), and does not engage in forward-exchange transactions. These foreign reserves exist (1) because local notes have been issued in exchange, or (2) because commercial banks must, by regulation, deposit a minimum reserve at the Currency Board. (1) generates a seignorage revenue. (2) is the revenue on minimum reserves (revenue of investment activities less cost of minimum reserves remuneration)
A currency board has no discretionary powers to affect monetary policy and does not lend to the government.
Official source
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