How a Currency Board Works

Under a currency board, the management of the exchange rate and money supply are given to a monetary authority that makes decisions about the valuation of a nation’s currency. Often, this monetary authority has direct instructions to back all units of domestic currency in circulation with foreign currency. When all domestic currency is backed with foreign currency, it is called a 100% reserve requirement. With a 100% reserve requirement, a currency board operates similarly to a strong version of the gold standard.

The currency board allows for the unlimited exchange of the domestic currency for foreign currency. A conventional central bank can print money at will, but a currency board must back additional units of currency with foreign currency. A currency board earns interest from foreign reserves, so domestic interest rates usually mimic the prevailing rates in the foreign currency.

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