Is a currency board an efficient exchange rate regime?

A currency board is an exchange rate regime where: The exchange rate is strictly pegged to a reference currency; The fixity of the exchange rate is ensured by a monetary policy that is subordinate to maintaining a set link between the quantity of money and the level of foreign exchange reserves. A loss (for example) of foreign exchange reserves (due to a trade deficit or to capital outflows) requires a proportional reduction in the money supply (therefore a highly restrictive monetary policy) that stabilises foreign exchange reserves. To assess the efficiency of a currency board and the potential costs associated with this exchange rate regime, we analyse developments in two countries that have chosen to operate a currency board: Hong Kong (with the dollar) and Bulgaria (with the euro). We find that the main costs associated with this option are: Asset price bubbles when the currency appreciate s as a trend ; Falls in asset prices and weak growth when the currency depreciate s as a trend .