Hong Kong’s Currency Mechanism And Its Implications For China

A currency board, first introduced in the British colony of Mauritiusin1849, is a rule-based monetary institution that is rather different from acentral bank. Since its introduction, there have been more than70countries or regions adopt this system, most of which belong to theBritish colony. It is regarded as one of the three dominant monetarysystems of the20th century, together with the central banking system andthe free banking system.Hong Kong’s linked exchange rate system belongs to the currencyboard system, but compared to the traditional currency board system, ithas several new changes. Established in1983, the linked exchange ratesystem of Hong Kong has gone through three stages of improvement,thus has some characteristics of the central bank system. Under thecurrent linked exchange rate system, there exist an automatic adjustmentmechanism. When the international balance of payments has surplus, themonetary base also increase, along with the increase of domestic pricelevel and the lower of interest rates, thus offsetting the prior inflows. Andvice versa, in this paper, through the two-way Granger causality test and pulse analysis of base currency amount and balance of payments data, weverify the existence of such an automatic adjustment mechanism.Hong Kong’s improvement of linked exchange rate system has someinspiration to the continent’s monetary policy. China should learn thequick react of Hong Kong government when faced with challenges. AndChinese government should also improve its credibility and avoid the"flip-flop" in order to win the trust of the people.