Currency Board Arrangements. Rationale for Their Introduction, Advantages and Disadvantages

some in a successful way, other to a less extent30. That is why, the choice of a rulebased, institutionally implemented rather than a discretionary form of monetary policy was preferable as it was easier to apply and offered transparency in the decision-taking process. The third great advantage of a currency board is that it builds in a payment adjustment mechanism. This is none other than what has often been identified as the gold-standard adjustment mechanism. Thus a country is not exposed to any temptation of engaging in support of balance of payment operations that can be very expensive and devastating31. The final advantage of the CBA is that because of the preceding three featuresassured convertibility, discipline over fiscal policy and inflation, and certainty of a payments adjustment mechanism-a currency board has good perspectives of maintaining the confidence of the public in general and the financial markets in particular. It should be relatively immune to speculative crises induced by fears of devaluations. B. Disadvantages Some of the criticisms of CBA have already been mentioned in Chapter.II.3. Here we adopt the approach of a “country in transition” while reviewing the disadvantages of the CBA. The seigniorage problem refers to the absence of domestic credit by the central bank that implies the inability of the monetary institution to control the monetary creation. The experience shows that in most of the cases the transition economies’ governments used to abuse with this source of revenue. So, tying one’s hands with [...]

The Central Bank of the newly independent Bosnia and Herzegovina began operations in 1997 according to the Dayton peace agreement. It acts as a CBA issuing a local currency- convertible marka (KM), which is pegged to the euro at rate of 1KM=0.511292 Euros. The aim of the currency board was to have the newly born local currency displace the four currencies that used to circulate in BH during the civil war and, in the meantime, to become a symbol of national unity. A specific feature of this CBA is that for the first six years of its operation the governor is appointed, after consultation with the government, by the IMF, and must not be a citizen of Bosnia and Herzegovina or a neighboring state. It is an orthodox CBA, i.e. no “lender of last resort” clause stipulated in the law establishing the BHCB: ”The central bank may not extend credit by creating money”. Credibility: as during the civil war, the Deutsche mark was the only currency people trusted in, the choice of the anchor currency made and the transparency of the [...]

All in all, Estonia’s currency board arrangement has played an important role in the country’s macroeconomic stabilization in general and in lowering the inflation in particular. It has contributed to Estonia’s economic growth (10.4% in 1997!) by increasing both the public’s and the foreign investors’ confidence in the soundness of the policymaking, with a strict monetary and a sound fiscal policy being pursued (See Appendix, Table 1). Performance: The automatic mechanism of the Estonian CBA was tested several times, the most serious test being the Asian and Russian crisis of 1997-1998. The fast response of the interest rates is an indirect proof of the smooth functioning of the CBA. (See Appendix 1, Fig. 1) [...]