Edited by Andrew W. Mullineux and Victor Murinde
Chapter 6: How to Tie Your Hands: A Currency Board versus an Independent Central Bank
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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