Author: Sau San Chan

Publisher:

Published: 2014

Total Pages: 0

ISBN-13:

Hong Kong is a unique case in the world history of exchange systems. As a territory under British administration for more than 150 years, it has maintained a floating exchange rate relationship with its sovereignty power in a separate currency area for more than a century. This exchange arrangement once existed with a peculiar institutional setting that the government had no control over the monetary base. In the post-1997 era, the survival of this "one country, two currencies" model depends on whether the authorities will continue to allow the HK dollar to float against the Renminbi. Based on the theory of optimum currency areas, this paper, with the ultimate objective to identify the optimal choice of exchange rate regime for HK, explores the economic rationale behind these interesting phenomena. The two inter-related issues--the choice of fixed versus floating exchange rate regimes and the optimal target of link currency--are addressed. It is argued that the structural characteristics and the development of monetary institutions have been the crucial determinants of the optimal exchange system for the sub-national economy. Our findings provide new interpretations regarding the monetary crisis in October 1983 and the monetary reforms since July 1988 and delineate policy implications for the exchange arrangements before and after 30 June 1997. It is suggested that HK should stay in the U.S. currency area, which has a floating exchange rate relationship with the currency area of the Territory's sovereignty power. The "one country, two currencies" model should be intact as long as the structural characteristics of HK remain unchanged. This paper also adds value to the empirical studies of optimum currency areas, which have been dominated traditionally by the verification of the diversified choices between fixed and floating exchange rate regimes and contemporarily by the justification for the EMU. It represents the first effort to deal with a model of many currencies for one country since R. Mundell introduced the idea that the domain of optimum currency areas should be defined by structural characteristics rather than national boundary in 1961.