What is a 'Currency Board'

A currency board is an extreme form of a pegged exchange rate, in which management of the exchange rate and the money supply are taken away from the central bank.

BREAKING DOWN 'Currency Board'

In a currency board, the management of the exchange rate and money supply are given to a monetary authority that makes decisions about the valuation of a nation's currency, specifically whether to peg the exchange rate of the local currency to a foreign currency, an equal amount of which is held in reserves. Often, this monetary authority has express instructions to back all units of domestic currency in circulation with foreign currency. In this way, a currency board operates not unlike the gold standard. 

The currency board then allows for the unlimited exchange of the local, pegged currency for the foreign currency. Unlike a conventional central bank, though, which can print money at will, a currency board issues domestic currency, putting additional units into circulation, only when it has the foreign-exchange rates to back it.

A currency board can only earn the interest that is gained on the foreign reserves themselves, so those rates tend to mimic the prevailing rates in the foreign currency.

Currency Boards: Where and Why?

Like most of the world's developed economies, the United States does not have a currency board. In the U.S., the Federal Reserve is a true central bank, which operates as a lender of last resort, engaging in forward contracts and trading Treasury securities in the open market. The exchange rate is allowed to float, and is determined by market forces as well as the Fed's monetary policies.

By contrast, currency boards are rather limited in their power. They essentially hold the required percentage of pegged currency that has been previously mandated, and exchange local currency for the pegged (or anchor) currency, which is typically the U.S. dollar or the euro

Under currency board regimes, interest rates will adjust automatically. When investors switch out of the domestic currency, into the currency it is pegged against, this shrinks the domestic currency supply, raising interest rates, until investors find it attractive to hold the domestic currency, according to the Economist.

Currency board regimes are utilized for their relative stability, and rule-based nature. Currency boards offer stable exchange rates, promoting trade and investment. Its discipline restricts government actions, too, for example, wasteful or irresponsible governments can't simply print exorbitant amounts of money to pay down deficits. 

Currency Board Weaknesses 

Currency boards have their downsides, though, too. In fixed exchange-rate systems, currency boards don't allow the government to set their interest rates. This means that the interest rates are set by the regulatory board that controls the currency that a local currency is pegged to.

It also means that, in cases where domestic inflation is higher than inflation in the foreign country of the currency the domestic currency is pegged to, the currency of that country with a currency board is in danger of massive overvaluation, which could make it uncompetitive.

And, if investors offload their local currency quickly, en masse, interest rates can rise very quickly, compromising banks ability to maintain appropriate, legal liquidity levels. This is dangerous for countries with fledgllng banking industries. 

Finally, unlike central banks, currency boards cannot act as a lender of last resort, meaning that in the event of, let's say, a banking panic, a currency board could not lend money to the bank in a meaningful way. 


  1. International Currency Exchange ...

    An international currency exchange rate is the rate at which ...
  2. Exchange Rate

    An exchange rate is the price of a nation’s currency in terms ...
  3. Foreign Currency Effects

    The gain or loss on foreign investments due to changes in the ...
  4. Permitted Currency

    A currency that is free from legal and regulatory restrictions ...
  5. Reciprocal Currency

    In the foreign exchange market, a currency pair that involves ...
  6. Reserve Currency

    A reserve currency is held by central banks and other major financial ...
Related Articles
  1. Insights

    The Currency Board: Understanding The Government's Bank

    Currency board, central bank - what's the difference? Find out more about this little-known monetary authority.
  2. Trading

    Currency Exchange: Floating Rate Vs. Fixed Rate

    Baffled by exchange rates? Wonder why some currencies fluctuate while others are pegged? This article has the answers.
  3. Trading

    The Effects Of Currency Fluctuations On The Economy

    Currency fluctuations are a natural outcome of the floating exchange rate system that is the norm for most major economies.
  4. Trading

    Drastic Currency Changes: What's The Cause?

    Currency fluctuations often defy logic. Learn the trends and factors that result in these movements.
  5. Trading

    Interest Rate and Currency Value And Exchange Rate

    In general, higher interest rates in one country tend to increase the value of its currency.
  6. Trading

    The 6 Most-Traded Currencies And Why They're So Popular

    Every currency has specific features that affect its underlying value and price movements in the forex market.
  7. Investing

    What Is A Currency War And How Does It Work?

    We look at what a currency war is, what factors may lead to it, the impacts of such a strategy, and whether there is a currency war currently.
  8. Trading

    A Primer On Currency Regimes

    Currency regimes are dynamic and complex, reflecting the ever-changing landscape of their respective nations' monetary and fiscal policies.
  9. Trading

    How to Calculate an Exchange Rate

    Struggling to get a grasp on exchange rates? Here's what you need to know.
  10. Investing

    Will the Yuan Become an International Reserve Currency?

    Although still a matter of when, China is likely to reach a significant milestone when the International Monetary Fund decides to include the Chinese yuan in its special drawing rights basket ...
  1. What is foreign exchange?

    Foreign exchange, or Forex, is the conversion of one country's currency into that of another. In a free economy, a country's ... Read Answer >>
  2. How do central banks acquire currency reserves and how much are they required to ...

    A currency reserve is a currency that is held in large amounts by governments and other institutions as part of their foreign ... Read Answer >>
  3. Why is the U.S. dollar shown on the top of some currency pairs and on the bottom ...

    All currencies are traded in pairs. The first currency in the pair is called the base currency while the second is called ... Read Answer >>
  4. How do you make money trading money?

    Trading money, particularly in the forex market, is a speculative risk, as you are betting that the value of a currency will ... Read Answer >>
Hot Definitions
  1. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  2. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  3. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  4. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
  5. Leverage Ratio

    A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or ...
  6. Annuity

    An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income ...
Trading Center