Modern currency boards are not necessarily precluded from
financing government spending and may feature only partial foreign
reserve backing. The potential dangers are highlighted by the Cook
Islands case, where accelerating rates of currency issuance, combined
with rising government budget deficits, led to a crisis of confidence
in 1994. It is unlikely that the seigniorage gained from the
short-lived currency board experiment outweighed the costs associated
with the swings in policy. In the end, delayed fiscal retrenchment
was accompanied by an abrupt contraction in the money
supply as the local currency was withdrawn in 1995 and full dollarization
re-established.
A country that is willing to give up an independent monetary policy
always has the option of simply adopting an established foreign
currency (such as the U.S. dollar) as the local circulating medium
and “dollarizing” the economy. This practice ordinarily offers no
scope for government revenue from money creation, however, leaving
all such “seigniorage” revenue to accrue abroad. An “orthodox”
currency board, limited to issuing domestic notes and coins that are
Modern currency boards are not necessarily precluded fromfinancing government spending and may feature only partial foreignreserve backing. The potential dangers are highlighted by the CookIslands case, where accelerating rates of currency issuance, combinedwith rising government budget deficits, led to a crisis of confidencein 1994. It is unlikely that the seigniorage gained from theshort-lived currency board experiment outweighed the costs associatedwith the swings in policy. In the end, delayed fiscal retrenchmentwas accompanied by an abrupt contraction in the moneysupply as the local currency was withdrawn in 1995 and full dollarizationre-established.A country that is willing to give up an independent monetary policyalways has the option of simply adopting an established foreigncurrency (such as the U.S. dollar) as the local circulating mediumand “dollarizing” the economy. This practice ordinarily offers noscope for government revenue from money creation, however, leavingall such “seigniorage” revenue to accrue abroad. An “orthodox”currency board, limited to issuing domestic notes and coins that are
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