Sept 26, 2009 (LBO) – The virtues of a currency board system were hotly debated at an annual confab of top economists in Sri Lanka’s capital Colombo, as the island emerged from its latest balance of payments crisis caused by an unstable peg. Sri Lanka was exposed to balance of payments crises after 1950 when then finance minister J R Jayewardene created a pegged exchange rate central bank with money printing powers, abolishing a currency board arrangement.
A currency board only targets a fixed exchange rate and is ‘hard pegged’ to the paper of a low inflation central bank, cannot print money to manipulate interest rates, cannot print money to bailout banks, and cannot print money to fill foreign exchange outflows.
It cannot print money to finance the government deficit. It can only buy and sell domestic money for foreign exchange at a fixed exchange rate, under a simple non-discretionary rule allowing the money supply to be determined by the balance of payments.
“The currency board system that prevailed in colonial times linked the money supply to the foreign exchange earnings and prevented excessive monetary expansion,” vice president of the Sri Lanka Economists Association (SLEA), R M B Senanayake sai