Role of Currency Board explained

Currency Boards have been set up by many economies, big and small across the globe. A currency board is a country’s monetary authority (in India we do not have currency board, RBI issues currency notes), which is basically entrusted with the responsibility of issuing currency notes and coins. The currency board also takes decisions about the valuation of a nation’s currency in a regime of the fixed foreign exchange rate of a currency. Such decisions are taken by it specifies whether to make downward adjustment of the value of a country’s money and set a new fixed rate with respect to a foreign reference currency (the currency of other nation) or currency basket. Although the currency board is the monetary authority, it is not the lender of last resort or banker to the Government like a Central Bank of the country. If a bank is failing, the currency board will not bail it out. In the other words, currency board has no role in conventional central banking roles like monetary policy and supervision and regulation of the banking and financial systems.

The unlimited notes and coins issued under minimum reserve system are called the Fiat money. The cost of the issuing fiat currencies is paltry compared to their face value.  Since the fiat currencies are issued and underwritten by the concerned government which is in principle, answerable to its citizen get their value by dint of regulation or law. The currency board in question follows certain strict rules while issuing currency notes. It seldom issue fiat money but instead will only issue one unit of local currency for each unit (or decided amount) of foreign currency it has in its vault (often a hard currency such as the U.S. dollar or the euro). Currency Board commits itself to converting it on demand to a specified currency at fixed rate of exchange. To make this commitment credible the board holds reserves of foreign currency (or of gold or some other liquid asset) equal to at least 100%of the domestic currency issue at the fixed rate of exchange. The Board issues currency only when there are enough foreign assets to back it. They can also form a credible commitment to low inflation since the only means a government has to raise necessary funds is through taxation or borrowing, not by printing more money (a major cause of inflation).