Fixed Exchange Rate
“Is the fixed exchange rate regime still appropriate for Hong Kong? What are the Alternatives?”
A. Is the fixed exchange rate regime still appropriate for Hong Kong?
Before, most of the nations in the world are implementing fixed exchange rate system, however, due to the different downfall and failure in many economies, together with the different changes in the political, economic and social conditions in local and international environment, countries started to implement other types of regime, including Singapore – which had implemented the fixed exchange rate system for a long time. The application of fixed exchange rate regime in Hong Kong had been very helpful in maintaining the level of performance of the city. For a long period of time, this regime had helped the city to maintain its level of economic performance, particularly because of its size and its ability to maintain good flow of economic processes in the city. However, currently, there are different factors in the environment which affect its application of regime. This pertains on the changing economic conditions of the countries around it, particularly the improvement of the economies of Mainland, China, and the continuous growth of Korea, Japan, Singapore etc. On the other hand, the country is also being affected by the changes in economic condition of the US and other European nations. In addition, for the past few years, Hong Kong is also showing slow down of growth in different economic activities. With this, it shows the inappropriateness of the system in Hong Kong.
Different studies show the different impact of the fixed exchange rate regime towards the macroeconomic policy of Hong Kong and its overall impact on the economy. Particularly, the regime can affect how the monetary policy is being managed and maintain– because of the link from the US, the interest rate of the city cannot diverge from the interest rate of the US by a significant margin. With this, the interest rate of the growth or performance of the city’s interest rate will always be dependent in the US. Furthermore, the government cannot use open market operations in order to influence its money supply – which makes Hong Kong to lose its independent policy; therefore, there are some economic and political opportunities which the company cannot take advantage of due to this relationship. In terms of fiscal policy, in order for the government of the city to maintain the confidence of the people in the link exchange, it is important to maintain a huge reserve, at the same time, keep a budget balance in a medium manner. In connection, it is also vital for the government to maintain a very flexible economic system, in order to cope with the demands of the fixed exchange rate regime. Based on this, because of the constraints on the monetary and fiscal policies, the government of Hong Kong has limited power and authority to control the different business cycles in the city; this is because it is important for the city to prevent any risky decisions that might cause fall of economy. Overall, it gives the city less means to defend the economy of the city from shocks and less ability to adjust and huge risk to exit. It can also result to the absence or lack of a lender-of-last resort and the city has to handle the cost of maintaining large foreign reserves (Lingnan University n.d.).
The study of Rajan & Siregar (2002) shows the difference between the economic situation of Singapore (upon change of exchange rate regime from fixed) and Hong Kong. The study showed that the exchange rate system helped to insulate the economy of Singapore from different external shocks until mid 1997; helped to maintain the Real Effective Exchange Rate (REER) at a consistent level. The study of Yip and Wang (2001) shows that the strong exchange rate regime of Singapore during the period of normalcy helps to maintain the inflationary tendencies under check, at the same time, enable the exchange rate adjustments during the presence of external shocks. On the other hand, in Hong Kong, between 1990 and 1995 the average inflation increased by 9%. The application of fixed exchange rate regime caused large-scale capital inflows which resulted to a sharp increase in domestic liquidity, absorbed mostly by the property sector which causes asset price bubble. It is important to take note that failure to undertake the needed requirements can cause to the loss of price competitiveness in the international markets and a build up of imbalances (Rajan & Siregar 2002).
B. What are the alternatives?
There are different alternative types of exchange rate regime which can be used in Hong Kong. The following are the alternative regimes which can be used and applied in Hong Kong in order to adjust on the macro- and micro-environmental environment, and prevent any future problems in the economy:
- Pegged exchange rate regimes. Adjustable pegs – where in the currency is fixed against a foreign currency and is seldom changed; and crawling pegs – where in the currency is fixed in initial stages, but the policymakers consequently changes in inflation differentials or in any circumstance of trade balance.
- Flexible exchange rate regimes. This type of regimes allows the exchange rate to vary or change as answers to changes in demand and supply of foreign exchange (Agénor, 2000). Free float enables the central bank to get involved in the market for foreign exchange, while managed float is the otherwise. This can be implemented as interbank system or an auction system or combination. In the interbank system, the exchange rate is being discussed in a market of commercial banks and authorized foreign exchange dealers – where in the exchange rate is allowed to fluctuate at any time. On the other hand, in the auction system, export receipts are submitted to the central bank at the existing exchange rate and the central bank, in turn, come to a decision about what amount of foreign exchange must be auctioned (Agénor, 2000).
- Band regimes. This type of regime includes the declaration of a central exchange rate and fluctuation band around that precise rate. The exchange rate is handled in different manner – fixed or crawling. The implicit commitment of the central bank is to get involved dynamically at the margins of the band in order to thwart the exchange rate from moving outside the band. The execution of a band is also in need of the adoption of a set of rules to channel foreign exchange market involvement, if any, within the band.
- Dual or multiple exchange rate regimes. The commercial transaction happens at fixed rates and financial transactions at a commonly more depreciated floating rate. This is taken on as momentary arrangements before the process of fixing the exchange rate to an equilibrium value (Agénor, 2000).
Agénor, P. R. (2000). The Economic of Adjustment and Growth, Academic Press.
Auerbach, A. & Kotlikoff, L. (1998). Macroeconomics: An Integrated Approach. MIT Press.
Dodsworth, J. & Mihaljek, D. (1997). Hong Kong, China: Growth, Structural Change, and Economic Stability During the Transition, International Monetary Fund.
GovHK. Hong Kong’s Linked Exchange Rate System. Retrieved May 17, 2010, from: http://www.info.gov.hk/hkma/eng/public/hkmalin/hkmalin_eng.pdf.
Gwartney, J., Stroup, R., Sobel, R. & MacPherson, D. (2008). Economics: Private and Public Choice. Cengage Learning.
Lingnan University. The Exchange Rate System & Macroeconomic Policy. Retrieved May 17, 2010, from: http://ln.ed.hk/.
Rajan, R. & Siregar, R. (2002). ‘Choice of Exchange Rate Regime: Currency Board (Hong Kong) or Monitoring Band (Singapore)?’, Blackwell Publishing Ltd/University of Adelaide and Flinders University of South Australia. Retrieved May 17, 2010, from: http://www.freewebs.com/.
Yip, P. & Wang, R. (2001). ‘On the Neutrality of Exchange Rate Policy in Singapore’, ASEAN Economic Bulletin, vol. 18, pp. 251 – 262.