Tuesday, March 31, 2009

advantages of a currency board

four major advantages are usually cited when comparing a currency board arrangement with a central bank with discretionary control of the money supply.
1- A currency board ensures convertibility .the maintenance of a 100 percent reserve system makes it certain that assets are available to cover any demand for conversion into foreign currency .
2- a currency board instills macroeconomic discipline .because the currency board is prohibited from buying domestic assets,it cannot finance a fiscal deficit .the government is forced to borrow from the public at home or aboard or maintain a balanced budget.in other words ,the government cannot simply "print money" to finance a government budget deficit since the money supply is strictly tied to the quantity of foreign exchange held by the currency board .it is hence also argued that a currency board will secure discipline over inflation .the process of tying the local currency to a reserve (and presumably low inflation) currency at a fixed exchange rate enhances price stability.
3- A guaranteed payment adjustment mechanism is provided. The payment adjustment mechanism is simply the gold-standard adjustment mechanism that is actually aversion of David Hume is price-specie-flow mechanism .these three advantages combine to create greater confidence in the system.
4- the increased confidence leads to the promotion of higher rates of trade ,investment ,and growth.

No comments: