Essay On The Linked Exchange Rate System

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Assessment of the Linked Exchange Rate System of Hong Kong I. Introduction Hong Kong has adopted its current exchange rate system i.e. linked exchange rate system since October 17, 1983. The linked exchange rate system is the cornerstone of the financial system of Hong Kong. The linked exchange rate system ensures that the Hong Kong dollar has a relatively stable value against other currencies. This stability plays an important part in supporting Hong Kong’s role as an international financial center. I’m writing this paper to discuss the operation, costs and benefits of the linked exchange rate system and possible resolution to its problems, and I believe that the linked exchange rate system has performed successfully over the past 30 years. II. Operation of the Linked Exchange Rate System Under the linked exchange rate system, the Hong Kong dollar is linked to the U.S. dollar at the rate of HKD 7.8 to USD 1. Unlike the fixed exchange rate regime implemented in other economies, under the linked exchange rate system, the government or the de facto central bank of Hong Kong, HKMA does not actively interfere in the foreign exchange market by controlling the supply and demand of the Hong Kong dollar in order to influence the exchange rate. According to John Greenwood (2008), the linked exchange rate system is a currency board system, which requires both the stock and flow of the monetary base to be fully backed by foreign reserves. This implies that any change in the monetary base is fully matched by the corresponding change in foreign reserves at a fixed exchange rate. According to the HKMA, the monetary base of Hong Kong is made up of the following four components: 1). Certificates of Indebtedness; 2). Government-issued notes and co... ... middle of paper ... ...d or removed, or turned into “a corridor for the exchange rate (against the US dollar or the RMB or an undisclosed basket of currencies)”. In general, it’s better for Hong Kong to keep the current exchange rate regime as the consequences of those proposals are still not clear. V. Conclusions I agree that the linked exchange rate system has served Hong Kong well since 1983, especially during the Asian Financial Crisis in 1998. According to Chan Tak Lam (2013), there is no need for Hong Kong to change its current exchange rate system because “the linked exchange rate system is still the most appropriate regime for Hong Kong after examining various alternative regimes”. However, Hong Kong government or particularly the HKMA should follow the economic situation of Hong Kong and of the world carefully in order to implement the suitable exchange rate system for Hong Kong.
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