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Issues In Money, Banking And Finance: Theoretical Perspective (Essay Sample)

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Outline the conditions for the success of a Currency Board in a modern economy. What types of economy are suitable for a Currency Board system?

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Issues in money, banking & finance Outline the conditions for the success of a Currency Board in a modern economy. What types of economy are suitable for a Currency Board system? Contents TOC \o "1-3" \h \z \u Introduction PAGEREF _Toc511574649 \h 3Theoretical Perspective PAGEREF _Toc511574650 \h 3Evidence – Currency Board in Hong Kong and Argentina PAGEREF _Toc511574651 \h 5Analysis and Discussion PAGEREF _Toc511574652 \h 8Conclusion PAGEREF _Toc511574653 \h 10References PAGEREF _Toc511574654 \h 11Appendix PAGEREF _Toc511574655 \h 14 Introduction With the rise of financial and accounting complications across the world and countries making efforts to accelerate their growth, multiple strategies are being applied for economic efficiency. From maintaining a certain level of inflation and interest rate to controlling the exchange rate of the economy, many policies are active in a particular time period so that the economy can reach its short and long-term economic goals (Saleh, 2004). When it comes to maintaining a balance of payment in an economy, countries have started to rely on multiple internal financial bodies to not only divide the work of these regulators, but make sure that a secure financial and monetary system is in place. One key in this process is a currency board, and the purpose of that is to necessarily take the money supply and exchange rate management from the central bank so that it can focus on other things while the board itself acts as a monetary authority (Balino & Enoch, 2017). In any economy, whether it is developed or a developing one, multiple factors need to be in place while developing a currency board. That is so because the board can handle all the monetary arrangements and play an essential role in strengthening the economy. Historically, many countries including Argentina, Estonia, Bulgaria, Hong Kong and Lithuania, etc. has taken steps of putting a currency board in place. It turned out to be a success in some cases while a failure in others (Chan, 2013). This essay will analyse the development of currency board in theory and practice. The next section of the essay will put light on the theoretical part of a currency board development and underlying factors. The next section will talk about two extreme examples when the board was a success and a failure. The second last section will provide an analysis and discussion on the topic while the last section will conclude the essay. Theoretical Perspective Why is it useful? According to Hanke (2012), currency boards are said to be a robust monetary development tool for many countries struggling with financial stability. This is because it provides them with a profound framework for the currency to get developed while the currency also has a significant amount of foreign exchange reserves to back up the entire system. It is primarily an alternative to minor capital and money markets and makes the economy more regulated. Many countries across the world including several in Asia, Europe and Latin America have started to implement these boards and integrate them into their monetary systems to strengthen their currencies. Not only do these benefit the currency but the economy as well (Joy, 2014). Theoretically, it is a play of many factors that make the model lucrative and factors included in it are capital inflow, outflow, investments, the value of assets and government involvement. Pautola (2010) mentioned that while the board is a quick and stable way for the currency and economy to grow, there has also been an argument that this is not an ultimate fix for any economy. That is true because, with more economic growth and financial stability in the country, many industrial, infrastructural and technological changes take place in the country, which eventually makes the financial model get diversified. When the gap between the developed and the developing countries start to bridge through the board, unnecessary reliance on the currency board can make the markets in the developing world more volatile and sensitive to market risk (Begovic, Adnett, & Pugh, 2016). In that case, anything ranging from the value of assets, income, land value, prices and other things can get devalued. Not the Final Solution Keeping that limitation in mind, Debowicz (2016) argue that no matter if an economy is substantially dependent on a currency board, it should understand and possess the capacity to make the transition to the primary monetary system that is under the central bank of the country. Since the future business and monetary policy formation will always be under the central monetary body in a country, it should already have that exposure that the currency board is just a final and temporary resort but will never be a permanent fix. The central body should understand that economies are operating on a currency board and realise this reliability period of the board and have a transition plan already in place to make the departure smoother. In this way, when a transition happens, the currency does not drop and gains enough power to stay stable (Aleksandar, 2018). After a developed economy gets out of the currency boards system, it has enough time to fix the economy and make sure that the central bank and other major monetary bodies in the country have the necessary skills and resources to stabilise the currency. Balgov & Funke (2016) also related these currency boards with fixed exchange rate regimes. In the presence of currency boards, open market operations reduce to a large extent while there are also limitations regarding setting up the central monetary policy for the economy. The way currency boards work provides a deep insight into what limitations they follow while operating in the economy. For instance, they are responsible for issuing a fixed-value currency in the economy, which is based on the currency that is issued by another country (Chiu, 2018). This currency is backed up by a significant number of deposits and reserves and therefore, some argue that currency issued by the board is much more reliable than the regular market, but this issue is still debatable. The total value of exchange rate in a country is one of the very initial and significant things to get fixed as a result of the currency board. While following a pre-decide rate of exchange and acting like the central bank, the board still cannot be the main monetary regulator and has limitations on OMOs, deposit auctions, money supply base and other functions that are common for the central bank (Klinger & Weber, 2016). Real-Life Cases Some of the major examples of currency board developments and their impact on the currency and its market state are the cases of Argentina, Estonia, Hong Kong and Lithuania. In the late 20th century, the rate of inflation in these countries dropped to a significant extent as shown in figure 1 in the appendix. One of the reasons of this drop in the inflation rate the fact that with the development of currency boards, these countries can hold money with a healthy reserve base which eventually makes it possible and more accessible for the rate of inflation to drop. That is what happened in these countries when they were able to facilitate investments and make their monetary systems stronger. Currency boards are reliable because they make the currency convertible while also have a reasonable level of international acceptance (Rogoff, 2014). Although currency board is a simple model that allows a smooth transition to the central bank when the economy stabilises, many other options can be considered in this regard. For instance, Lam (2014) suggested that transaction costs that can be reduced due to a fixed exchange rate in an international trade exchange with another country. Political support is another aspect which needs to be considered while making a transition from the central bank or currency board or vice versa. While the central bank has much more burden of supporting the economy and devising a robust monetary policy, currency boards do not require that level of engagement and knowledge and are free from the worries of any underlying results of the transition. However, some argue that the inability of a currency board to be a lender of the last resort can make it less efficient and prevent the economy from having a full disclosure (Wei, 2015). Evidence – Currency Board in Hong Kong and Argentina History has many examples of currency boards that developed to sustain the monetary stability and strength of an economy. There were two historical examples of success and failures of these boards when it was a success in Hong Kong and a failure in Argentina. IMF states many cases of exchange rate systems, one out of which is a currency board (White, 2016). Hong Kong decided to adopt this system to make its currency more stable for the long-run. As a result of it, the HK$ to US$ exchange rate in Hong Kong dropped and remained quite stable, after that Figure 2 in the appendix shows the historical exchange rate in Hong Kong. It is apparent that one of the most significant advantages that Hong Kong received from the development of the currency board is a stable and much lower exchange rate. This exchange rate was not a sudden and temporary fall in the inflation rate but was a somewhat permanent change that remained the same throughout 2018 (Ghosh, 2008). Chronologically, Hong Kong had an orthodox currency board in 1935-1972 while the anchor was abandoned in 1972-1983. This was the time when the economy realised that it needs several policy changes to make the economy grow. In October 1983, the currency board was restored with the US$ anchor. Due to the reliance on the currency board, the economy of Hong Kong started recovering from the financial challenges, and many macroeconomic and financial factors in the economy started improving including the exchange rate, inflation rate, monetary growth and interest rate in the count...
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