Currency Boards

Abstract

Currency boards have a long history, much of it in (mostly British) colonies and dependencies, typically smaller and more open economies. The historical evidence suggests that these boards succeeded in maintaining exchange rate stability and facilitating trade, at the cost of tying up reserves and restricting the scope for monetary policy, with more ambiguous evidence on their broader economic impact. Exits were generally to pegged regimes and proceeded smoothly.

A more recent group of currency boards was motivated by stabilization rather than trade considerations. While the sample is small, the lesson from their experience is straightforward (and unsurprising). Boards deliver short-term stabilization and an extended honeymoon period. Whether stability lasts depends on policy choices during the honeymoon period. Countries using the good times to achieve lasting fiscal balance while vigilantly counteracting real appreciation and prudently managing capital inflows stand to reap longer-term benefits at modest costs. Those that do not are likely to face an unpleasant reckoning with reality a few years down the line. The latter experience has been more common: both Argentina and the Baltics eventually faced crises reflecting external developments aggravated by domestic political choices. The Baltics, with a clear exit path to the Euro, doubled down on the boards and eventually achieved a smooth transition. Argentina, lacking a clear longer-term transition perspective, shifted to a flexible exchange rate.

Overall, the experience suggests that CBAs are neither a low-cost panacea for all monetary ailments nor an overly restrictive arrangement all but certain to end in crisis. Rather, as with all exchange rate regimes, they promise specific benefits and come with specific costs, necessitating a careful consideration of the trade-offs in the particular circumstances.