Building a Case for Currency Boards

Two common objections to currency boards are that they are dominated by more flexible policies and that they are unsustainable. The paper confronts these objections with the insights from a model economy in which several constituencies who compete for subsidies do not have the ability to monitor the allocation of government spending. Such assumptions are meant to capture important features of the reality of many countries for which currency boards have been proposed. The model suggests that, in such environments, flexible policies in a certain class have an inflationary bias that a sustainable currency board can – but not necessarily – eliminate.