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Record of Discussion of the Meeting of the Exchange Fund Advisory Committee Sub-Committee on Currency Board Operations held on 3 May 2002

(Approved for Issue by the Exchange Fund Advisory Committee on 30 May 2002)

Currency Board Operations for the Period 27 March - 19 April 2002

1. The Sub-Committee noted that the period under review had been a quiet and calm one, in which the Hong Kong dollar and money markets had remained generally stable. The monetary base had decreased by HK$2.7 billion to HK$233.3 billion as public demand for cash declined after the holiday period and the outstanding amount of Certificates of Indebtedness accordingly declined. Members observed that, largely as a result of this, backing assets had decreased during the period and the backing ratio had increased quite markedly from 111.14% on 27 March to 111.96% on 19 April, bringing the ratio closer to the upper trigger level of 112.5%.

2. The Sub-Committee noted that, in accordance with Currency Board principles, changes in the monetary base during the reporting period had been fully matched by changes in foreign reserves.

3. The report on Currency Board operations for the period under review is at Annex A.

Monitoring of Risks and Vulnerabilities

4. The Sub-Committee noted that signs of recovery in the global economy continued to appear, although uncertainties about the durability and strength of the recovery remained, particularly since much of the increased economic activity in the US was attributable to increased government spending. Among the risks in the global environment was the fact that the US current account deficit continued to be very high, which could lead to a decline in the value of the US dollar and consequent instability in markets. Another risk was the uncertainty about oil prices in the light of the situation in the Middle East.

5. Members noted that the outlook for Hong Kong had been improved by the more favourable external situation, and there had been an increase in the value of exports of 5.7% in the first quarter of 2002 (quarter-on-quarter, seasonally adjusted). Domestic consumption was, however, likely to continue to be restrained by the rising unemployment rate.

6. Members noted two special issues in the report on this item. The first was an examination of the Japanese banking industry, which was still experiencing fundamental problems despite the reform measures implemented in the 1990s, and which was coming under increasing pressure from the persistent weakness in the Japanese macro-economy. The second issue was an examination of the likely impact of possible US interest rate increases on Hong Kong. Members observed that this question was of crucial importance to Hong Kong because Hong Kong dollar interest rates tended to follow US dollar interest rates and because of the large amount of foreign exchange reserves invested in US dollars. The conclusion of the study was that the positive effects of a US recovery (which, it was assumed, would be the main reason for higher interest rates) should more than offset the negative effects of interest rate increases.

Information Content of Monetary Aggregates: An Application of the P-Star Model

7. Members noted an information paper reporting on research that applied the p-star model, developed by the US Federal Reserve System, to Hong Kong to test the hypothesis that an excess real money balance implied potential inflationary pressure in the future. The empirical results from the research suggested that both narrow and broad real money gaps contained useful information about future inflation in Hong Kong. Nevertheless, there was no evidence that this model was any better than other models using the output gap or nominal money growth.

Extraction of US Dollar Interest Rate Expectations from Derivatives Prices

8. Members noted an information paper that examined the question of how market expectations of US dollar interest rates could be extracted from Fed funds futures prices and Eurodollar futures options prices. The paper's conclusion was that prices of both forms of derivatives offered useful information. The Fed funds futures provided the closest proxy for the Fed funds target rate, while the Eurodollar futures options prices were more informative in that they gave the whole distribution of future interest rates.

For further enquiries, please contact:

Thomas Chan, Senior Manager (Press), at 2878 1480 or
Sylvia Yip, Manager (Press), at 2878 1687

Hong Kong Monetary Authority
4 June 2002

Last revision date: 1 August 2011
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