Currency boards for developing nations: past experiences and feasibility for future adoption

Abstract

The objective of this study is to determine the importance of the economic discipline and interest rate arbitrage components in the mechanism that maintains the fixed exchange rate under a currency board arrangement. I argue that by understanding the mechanics of economic discipline and interest rate arbitrage, emerging economies are more likely to establish a successful currency board arrangement. A recent review of the literature has revealed the need to rigorously study the importance of these components of exchange rate maintenance in creating a successful currency board. Measuring the preconditions that comprise the components of the exchange rate mechanism is done on a case study basis of Hong Kong, and Argentina. The levels of the preconditions are used for the empirical estimation of the functioning of the exchange rate mechanism. Econometric analysis is then used to determine if the preconditions explain the theoretical understanding of the exchange rate mechanism. Finally, based on the conclusions, a number of recommendations will be suggested to increase the likelihood that a currency board arrangement created in an emerging economy will be successful.