What Are the Costs and Benefits of Currency Boards?

Master Thesis by Tamara Basic
October 16, 2003

Abstract:

The question of fixed or flexible, when it comes to exchange rate policy, has been an open one for all of the modern economic thought history. State of the art literature findings have been applied in practice, with more or less of success. In this paper I am giving a review of what the answers to this famous question might be, in a particular case of exchange rate policy, the monetary board. The model is presented, which provides proof that a one sided peg, hence a monetary board, contrary to common belief, is an optimal policy since it actually increases the nominal prices flexibility, this being the ultimate goal of the exchange rate policy in the first place. Solving this dilemma, the paper then turns to deal with the problems a monetary board might face in practice, mainly self-fulfilling crisis or the speculative attack risk. Again a model is provided proving that, currency crisis are showing a self-fulfilling character. Finally some conclusions, in the form of warnings and advices, are presented for countries pursuing monetary boards as their exchange rate policies.