When the central bank adopts a currency board, it is considered ______, because a shock to money demand _______.
A) a hard peg; can be covered at any level without a change in domestic credit
B) a soft peg; can be absorbed by a change in domestic credit
C) a reversion to floating rates; is impossible
D) the reinstatement of a gold standard; cannot be covered any other way

Question

Quizplus · Accepted Answer

When the central bank adopts a currency board, it is considered a hard peg because the exchange rate is fixed permanently, and a shock to money demand can be covered at any level without a change in domestic credit. In a currency board system, the central bank not only pegs the exchange rate but also commits to exchange domestic currency for a specified foreign currency at a fixed exchange rate. It must hold foreign exchange reserves equal to the amount of domestic currency in circulation that is backed by foreign currency. This means that the central bank cannot issue more domestic currency than it has foreign currency reserves, hence maintaining the exchange rate.

When the Central Bank Adopts a Currency Board, It Is