Currency board system - Financial definition
Concise definition of the term currency board system
A currency board arrangement is a type of exchange rate regime in which a country's currency is directly and strictly tied to a foreign currency at a fixed exchange rate.
Comprehensive definition of the term currency board system
In this system, a currency board operates as a monetary authority that pegs the domestic currency's value to a foreign anchor currency such as the U.S. dollar or the euro, maintaining a strict 1:1 exchange ratio.
This system restricts the currency board from engaging in discretionary monetary policy, as it must hold sufficient foreign currency reserves to cover the entire monetary base. Practical examples include the Hong Kong Monetary Authority, which pegs the Hong Kong dollar to the U.S. dollar, and the Estonian kroon (until 2011) which was pegged to the Deutsche Mark and later the euro.
The implementation of a currency board system is usually prompted by severe economic instability or crises that undermine confidence in the domestic currency and monetary policy. For example, countries experiencing hyperinflation, such as Argentina in the early 1990s, may adopt a currency board to anchor the currency to a more stable foreign currency, thus restoring trust and stability.
Additionally, small economies or those with a history of poor monetary management may establish a currency board to attract foreign investment and trade by providing a stable and predictable exchange rate. The choice of the anchor currency is strategic, often based on the primary trade partner or a globally stable currency like the U.S. dollar or the euro. Once established, the currency board limits the country's ability to conduct independent monetary policy, focusing instead on maintaining the fixed exchange rate through strict management of foreign reserves.