Choice of Exchange Rate Regime: Currency Board (Hong Kong) or Monitoring Band (Singapore)?

Abstract

Following the East Asian crisis, a number of observers have advocated that small and open economies in Asia adopt an irrevocably fixed regime. Such a hard peg, it is argued, signals greater commitment to rule out arbitrary exchange rate adjustments as well as the authorities' willingness to subordinate domestic policy objectives such as output and employment growth to the maintenance of the pegged exchange rate. But is this a reasonable position to adopt? In order to answer this question, we consider and contrast the experiences of Hong Kong and Singapore. While both of these economies share a number of broad similarities, the former operates a US dollar-linked currency board arrangement and the latter maintains an adjustable peg in the form of a monitoring band arrangement with the central parity based on an undisclosed trade-weighted currency basket. Copyright Blackwell Publishers Ltd/University of Adelaide and Flinders University of South Australia 2002.

An Optimal Currency Basket to Minimize Output and Inflation Volatility: Theory and an Application to Hong Kong

“…Based on their assessment of Hong Kong's and Singapore's track record regarding consumer price changes, interest spreads from the US prime rate, real interest rate levels and stability, trade‐weighted exchange rates, and real exchange rates against the US$, Lu and Yu (; p. 136) conclude that the ‘HK dollar's peg to the US dollar is a costly and inefficient regime’. Rajan and Siregar (; p. 554), after conducting statistical tests to identify the existence of real exchange rate misalignment and reviewing the experience of Hong Kong and Singapore, conclude similarly that ‘the more flexible intermediate exchange rate regime in Singapore has “outperformed” the Hong Kong's [sic] CBA in general, and particularly in the last decade when a series of external shocks hit the region, impacting both the economies’. They regard this as support for Williamson's view on the desirable properties of currency basket arrangements.…”

“…Lu and Yu () and Rajan and Siregar (), mentioned above, have provided criticisms of these ex‐post justifications by comparing Hong Kong's and Singapore's experience up to year 1998 and 2000, respectively.…”

Weakness in HK Currency Board System and Trading Opportunities in Betting A De-Peg of the Hong Kong Dollar

“…Hong Kong pursued such a discretionary policy in the 1990s, resulting in a sustained attack on the Hong Kong dollar in the midst of the crisis. (Rajan & Siregar, 2002) Professors Tse and Yip's research on interest rate behavior in two economies also shows that the monitoring band system in Singapore not only allows a greater flexibility in the choice of the exchange rate, but also a greater autonomy in the choice of interest rates to mitigate a crisis, recession or overheating. The loopholes and de-pegging risks of the currency board might imply a substantial exchange-rate risk for banks when conducting uncovered interest arbitrage.…”

“…Although the maintenance costs might outpace the exit costs, one cannot be sure if the end game is necessarily worth it. (Rajan & Siregar, 2002) Professor Yip suggests that although the exit cost is unknown, a stronger currency can mitigate the cost. He argues that if the US dollar enters a period of substantial depreciation and if the HK dollar is unpegged at this point, then the exit costs will be very small (or even negative) with the dollar up against USD-related currencies and relatively stable against other currencies.…”

Foreign interest rate shocks and exchange rate regimes in East Asia

“…Table 2 summarizes the sample periods and pegged periods for the nine East Asian economies. Among them, Hong Kong adopted a Currency Board Arrangement to fix the exchange rate at HK$7.8 per US Dollar since 1983 with the aim of preventing the Hong Kong dollar from collapsing in the midst of a political row between China and the United Kingdom over the future of the city (Rajan and Siregar, 2002). For the case of Singapore, the Singapore Dollar originally followed an exchange rate with a fixed link to a single currency and then pegged against a fixed and undisclosed trade-weighted basket of currencies.…”