by Norman S. Fieleke
November/December 1992

Some countries with high inflation have adopted another nation’s more stable currency: Panama uses the U.S. dollar, gaining price stability and easier trade with its primary partner. But this arrangement grants an interest-free loan to the government whose currency is used. And the nation using the currency forgoes any income on the foreign currency holdings.

One alternative, a currency board, achieves the other country’s monetary stability without these costs. Currency boards issue a domestic currency in return for the foreign currency, at a fixed exchange rate. Boards also hold assets denominated in the foreign currency that are at least equal in value--at a fixed exchange rate--to the total domestic currency issued. Some have suggested that currency boards might "rescue" the monetary systems of Eastern Europe and the former Soviet Union. The author expresses a number of reservations. Above all, it is unclear how a currency board can arrest inflation without like-minded government policies: "Dramatic results should not be expected from the inauguration of a currency board in the absence of other financial reforms."

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