by Richard W. Kopcke
May/June 1999

A currency board can allow a developing economy to establish its domestic currency relatively promptly and efficiently by fixing the value of its currency to that of another country and guaranteeing that its currency is backed by sufficient foreign exchange reserves. Currency boards not only provide a foundation that encourages traders and investors to accept new currencies, they also do not require sophisticated money markets and central banking operations in order to be effective. Because of these attributes, currency boards have attracted more attention, particularly in the wake of recent global financial crises, from developing countries in Asia, Latin America, and Europe that have either introduced new currencies or want to restore confidence in their currencies. The author reviews the design of currency boards, the choice of reserve currency and exchange rate, and the role of a currency board in fiscal and monetary policy. He concludes that while currency boards can provide a foundation for new currencies, these boards alone cannot ensure success. Although a board guarantees the backing of its base money, faith in its currency rests on traders' and investors' confidence in the economy's financial institutions, capital markets, and fiscal management. Although a board might cause its economy to import a reputable monetary policy, it cannot ensure that this policy suits its economy's needs. Currency boards represent a start, more than a destination, for the design of monetary authorities, the author concludes.

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