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Handbook of International Banking

Handbook of International Banking

Elgar original reference

Edited by Andrew W. Mullineux and Victor Murinde

The Handbook of International Banking provides a clearly accessible source of reference material, covering the main developments that reveal how the internationalization and globalization of banking have developed over recent decades to the present, and analyses the creation of a new global financial architecture.

Chapter 6: How to Tie Your Hands: A Currency Board versus an Independent Central Bank

Jakob de Haan and Helge Berger

Subjects: economics and finance, financial economics and regulation, money and banking


Jakob de Haan and Helge Berger 1 INTRODUCTION The proper design of monetary institutions is a very important issue for transition and developing countries alike. There seems to be broad support for the idea that price stability should be the prime objective of monetary policy. How should this objective be realized, that is, what is the proper monetary arrangement? This chapter will compare two options: a currency board and an independent central bank under flexible exchange rates. Developing and transition countries show considerable diversity in their exchange rate regimes, from very hard currency pegs to free floats and many variations in between. Exchange rate pegs can provide a useful and credible nominal anchor for monetary policy and avoid many of the complexities and institutional requirements for establishing an alternative anchor, such as a functional and credible inflation target backed by an operationally independent central bank (Mussa et al., 2000). A currency board can be considered as the most credible form of a fixed exchange rate regime as the own currency is convertible against a fixed exchange rate with some other currency(ies), which is codified, be it in a law or otherwise. The anchor currency is generally chosen for its expected stability and international acceptability. There is, as a rule, no independent monetary policy as the monetary base (or in the simplest case: banknotes) is (are) backed by foreign reserves (Pautola and Backé, 1998).1 Currency boards are back in fashion (Ghosh et al., 2000). Once they were...

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