Record of Discussion of the Meeting of the Exchange Fund Advisory Committee Sub-Committee on Currency Board Operations held on 3 March 2000

(Approved for Issue by the Exchange Fund Advisory Committee on 23 March 2000)

Currency Board Operations for the Period 1 - 25 February 2000

The Sub-Committee noted that during the period under review the Hong Kong dollar exchange rate had eased slightly prior to the Chinese New Year, partly as a result of increased purchases of US dollars by note-issuing banks as backing for additional banknote issuance over the New Year period. The Convertibility Undertaking had been triggered on a number of occasions in the first half of the period: the resulting shrinkage in interbank liquidity had led to a firming of local interest rates, and, with the sale of US dollars by note-issuing banks following the Chinese New Year period, the exchange rate of the Hong Kong dollar had strengthened slightly relative to the convertibility rate in respect of the Aggregate Balance. Members noted that these adjustments under the Currency Board system had proceeded smoothly and that changes in the Monetary Base had been fully matched by corresponding changes in foreign reserves in accordance with the Currency Board arrangements.

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

Model Simulations of the Currency Board Arrangements

3. The Sub-Committee was invited to consider the preliminary findings and possible further uses of a model-based analysis of the operations of the Currency Board system. Members were briefed on the principles and mechanics of the model, which analysed four key relationships influencing the workings of the Currency Board system: banks' liquidity demand, private sector demand for Hong Kong dollar assets, Discount Window borrowing demand, and currency market operations by the HKMA. Members noted that the model addressed the day-to-day workings of the currency and money markets and therefore did not take account of variables in the longer-term macro-economic background.

4. Members considered the results of a number of simulations under the model and observed that, while they were not a perfect substitute for historical experience, simulations offered two main advantages: they allowed operations to be tested under extreme conditions; and they provided opportunities to experiment with the design of the system. Members noted, in particular, from the findings of the simulations provided in the paper that the Discount Window facility, introduced in September 1998, would have supplied a more effective buffer against the speculative pressures earlier in 1998 than did the Liquidity Adjustment Facility then in place. Members also noted that the stochastic simulations in the paper suggested that the introduction of a Discount Window "bid" facility of the kind considered, but not pursued, at the Sub-Committee's meeting of 7 May 1999, could significantly raise reserve volatility in some circumstances.

5. Members considered that model simulations of the kind presented in the paper were valuable in facilitating a better understanding of the Currency Board arrangements. Members noted that the model under consideration was very much work in progress and agreed that there were complexities and imponderables in actual experience that could not be fully replicated in any model, however sophisticated. They advised, however, that the model should be developed and applied further to the HKMA's research into the workings of the Currency Board system.

Dollarisation Plan in Ecuador

6. The Sub-Committee noted an information paper on the latest developments in the Ecuadorian dollarisation plan.