Credibility of Hong Kong's Currency Board: The Role of Institutional Arrangements

Abstract

The paper shows that Hong Kong’s currency board in recent years has gone through three stages, a rule-bound regime, a regime based on discretion, and a return to fixed rules. A number of methods developed in the target zone literature have been used to measure the credibility of the system. The empirical results show that the currency board was most credible when the monetary authority adhered to fixed rules. Reliance on discretion contributed not only to the erosion of market confidence in the system, but also made speculative currency attacks during the Asian financial turmoil easier. (a) City University of Hong Kong; (b) Hong Kong University of Science and Technology. *Paper prepared for presentation at the tenth annual East Asian Seminar on Economics to be held in Hawaii on June 9-12, 1999. We are indebted to Alex Chan, K.C. Chan, YukShee Chan, Nai-fu Chen, and Merton Miller for useful discussions and comments. All remaining errors are ours. Financial support from the Research Grant Council of Hong Kong, under grant number HKUST6217/97H, is gratefully acknowledged.