Focused Research Area

Currency Board Economics and the AEL Model

(September 1998 – December 2003)

 Updated for changed links in 2010


Outside almost everyone's predictions, the speculative currency attacks in East Asia in the second half of 1997 resulted in unprecedented financial and economic turbulence in different regions of the world. The "contagion effect" spread to Hong Kong in late October 1997. Hong Kong's linked exchange rate regime, as a variation of the "currency board system", was successfully defended, but at considerable costs in terms of high and volatile interest rates. Difficulties including negative economic growth, high unemployment rate and dramatic asset deflation rapidly unfolded.

The method used by the Hong Kong Monetary Authority (HKMA) to defend the link was interpreted by many to rely on the active manipulation of interbank liquidity and interest rates. That was denied by the HKMA. In the midst of the controversy and the crisis, the Financial Secretary started a consultation exercise with academics in November 1997 to collect views on how to improve the link. Our colleague Prof. S. K. Tsang was one of those consulted. Prof. Tsang proposed to strengthen the system by adopting the AEL model of Argentina, Estonia and Lithuania, under which the central bank guarantees the convertibility at the fixed exchange rate of the whole monetary base (indeed all its financial liabilities), in stead of just the cash base as under the classical currency board. The proposal was also described by the mass media as the "Baptist University Proposal", in juxtapose with those made by academics in other sister institutions.

In its Report on Financial Market Review released in April 1998, the Hong Kong SAR Government rejected the major proposals by the academics. Intense speculation on the Hong Kong dollar was again seen from mid-1998 onwards. In response, the Government made a historical move by intervening in the stock and futures markets. On 5 September 1998, the HKMA announced the "seven technical measures", of which the first, and the most important one, was the "convertibility undertaking" on the aggregate balance of banks with the HKMA, a key element of the monetary base. It represented a partial adoption of the AEL model that Tsang had been advocating.

Hong Kong's exchange rate and interest rates had since shown much greater stability. Yet, tricky questions concerning the nature and the adjustment mechanisms of the link remained. The optimality of sticking to a peg in times of huge external disturbances was also an open issue.

The Department of Economics decided in September 1998 to establish a new focused research area on "Currency Board Economics and the AEL Model" to concentrate resources in conducting on-going research. Emphasis was also put on establishing external links that facilitate useful discussions.


The Research Team

Prof. Shu-ki Tsang (Coordinator)

Dr. Y. S. Cheng

Dr. Billy Mak

Dr. C.Y. Sin

External members

Dr. Yue Ma (Lingnan University)



November 1998 Conference

To provide a forum for rigorous analysis by scholars and experts from around the world on the general themes of exchange rate stability and currency board economics, the Department of Economics organised an International Conference on Exchange Rate Stability and Currency Board Economics on 28-29 November 1998. The conference was attended by participants from the HKMA, the World Bank, the IMF, the US Fed, the Bundesbank, as well as researchers and officials from other central banks, universities, institutions and commercial entities. Over thirty keynote speeches and papers were presented. Quite a few of them analyzed the theory of currency board economics and the specific currency board arrangements in Hong Kong, Argentina, Estonia, Lithuania and Eastern Europe. For the programme and other information of the Conference, a brochure is available here.

Members of our Research Team presented several papers in the Conference:

1. Shu-ki Tsang, Yuk-shing Cheng and Chor-yiu Sin, "The Robustness of Hong Kong's Linked Exchange Rate System as a Currency Board Arrangement."

2. Billy Mak, "Can Put Option Stabilize the Exchange Rate Under a Currency Board System?"

3. Shu-ki Tsang and Yue Ma, " Currency Substitution and Speculative Attacks on a Currency Board System." A revised version of the paper was later published in vol. 21, no. 1, Journal of International Money and Finance, 2002.


Seminar and Conference Presentations


Members of the Research Team undertook further research in the area. A project, "The Linked Exchange Rate as a Currency Board System: Market Efficiency, Regime Efficiency and Economic Optimality", was funded by a Faculty Research Grant of the HKBU. The Research Team also invited local and overseas academics to visit the HKBU to give seminar talks.

Prof. S.K. Tsang presented the following paper at the 6th Convention of the East Asian Economic Association in Kitakyushu, Japan on 4-5 September 1998:

"Fixing the Exchange Rate through a Currency Board Arrangement: Efficiency Risk, Systemic Risk and Exit Cost". The paper was published in Asian Economic Journal, Vol.13, No.3, September 1999.

Arranged seminars in 1999 (at 2:00 - 3:30 p.m., WLB 805B) included:

23 February 1999: Prof. Michael Devereux, UBC and visiting HKUST, "A Tale of Two Currencies: The Asian Crisis and the Exchange Rate Regimes of Hong Kong and Singapore."

23 March 1999: Dr. Stephen Chiu Yiu-wah, CUHK, "Are Multiple Equilibria of Currency Attack Feasible Only When Fundamentals are Common Knowledge?"

Two local seminar presentations were made by members of the Team:

24 February 1999: Prof. S.K. Tsang, "Varieties of Currency Board Systems and Hong Kong as a Special Case", luncheon talk given at the Hong Kong Society of Financial Analysts (HKSFA);

5 March 1999: Prof.S.K. Tsang, at the Economics Department of the HKUST, "On the Robustness of Hong Kong's Currency Board System."

And the following paper of team members was accepted for the 54th European Meeting of the Econometric Society held at Santiago de Compostela, Spain on 29 August - 1 September 1999:

Shu-ki Tsang, Chor-yiu Sin and Yuk-shing Cheng, "The Robustness of Hong Kong's Linked Exchange Rate System as a Currency Board Arrangement."

Prof. S.K. Tsang and Dr. C.Y. Sin attended the Meeting and presented the paper.


A seminar on the Bulgarian situation was organised:

11 October 1999: Prof. Lena Rousennova, The World Bank and Dr. Kalin Hristov, Bulgarian National Bank, “The Bulgarian Currency Board: Formation, Operation and Exit”


International Workshop on 9 October 1999


As a follow-up to the conference of November 1998, the Economics Department, under the full support of the Team, organised an international workshop on the theme "Currency Boards: Convertibility, Liquidity Management and Exit". Speakers included local and overseas experts and practitioners. For details, please refer to the web page (full set of papers and presentations available online).



Seminar on Currency Boards organised by Bank of Estonia, 5-6 May 2000


The Bank of Estonia organised a seminar on "Currency Boards: Experience and Prospects" in Tallinn on 5-6 May 2000. Prof. S.K. Tsang was invited to present a paper entitled "Commitment and Exit Strategies from a CBA". Making use of the trip to Tallinn, Prof. Tsang also visited the Bank of Estonia on 8 May and gave a talk on "The Evolution and Prospects of the Hong Kong CBA" to bank staff and other interested parties.



Participation in Policy Research


Prof. S.K. Tsang was appointed a Member of the Sub-Committee on Currency Board Operations of the Exchange Fund Advisory Committee of the Hong Kong SAR Government in November 1998. The Sub-Committee was a vehicle for the monetary authorities in Hong Kong to gauge the views of experts on the operations of the currency board regime in Hong Kong and on ways to further improve its robustness.


Prof S.K. Tsang was appointed a Member of the Council of Advisors of the Hong Kong Institute for Monetary Research (HKIMR) in September 1999. The HKIMR was a research centre established by the HKMA with the objective of promoting in-depth research on monetary, financial and economic issues relevant to Hong Kong and the Asian Region. Currency board economics was one of the areas of interest.


Prof. S.K. Tsang published a paper “Legal Frameworks of Currency Board Regimes” in the August 1999 issue of the Quarterly Bulletin of the Hong Kong Monetary Authority; while Dr C.Y. Sin published a joint paper with Kam-hon Chu and Bob Y.C. Chan entitled “Contagion Effects, Information Effects, and Economic Fundamentals: An Analysis of Exchange Rate Dynamics During the Asian Currency Crisis” under the Working Papers Series of the HKIMR (No. 02/2000).


Dr. Y.S. Cheng and Dr, Yue Ma, along with Prof. S.K. Tsang, were invited to attend academic consultation meetings by the HKMA on various topics relating to the currency board system in Hong Kong. Dr. Ma also served as Research Fellow at the HKIMR in July-August 2000.



Developments in 2001-2002


The following paper of team members was presented in the 2001 Far Eastern Meeting of the Econometric Society held at Kobe, Japan on 20 July - 22 July 2001: Chi-shing Chan (University of Hong Kong), Chor-yiu Sin and Yuk-shing Cheng, "High Interest Rate as a Signal of the Resolve to Defend Currencies." Dr. C.Y. Sin attended the Meeting and presented the paper.


Dr. Yue Ma and Prof. S.K. Tsang made an internal presentation at the HKIMR on an arbitrage model of exchange rate regimes including the currency board system in 2001.  


Prof. S.K. Tsang was invited to present a paper at the International Conference on Monetary Outlook on East Asia in An Integrating World Economy, Chulalongkorn University, Thailand, 5-6 September 2001. The conference was attended by Nobel Laureate Robert Mundell, and Ronald McKinnon, amongst others. Tsang's paper was entitled “One Country, Two Monetary Systems: An Eclectic Essay”. Besides the issues of monetary integration between Hong Kong and Mainland China, he illustrated the problems relating to how a currency board system could exit the peg, with reference to Argentina. The paper was posted as on Prof. Tsang's personal website.


Prof. S.K. Tsang continued to serve as a member he Sub-Committee on Currency Board Operations of the Exchange Fund Advisory Committee of the Hong Kong SAR Government and an advisor to the Hong Kong Institute for Monetary Research (HKIMR). He spent three months (October - December 2001) as a visiting research fellow at the HKIMR doing a project on "Monetary Integration between Hong Kong and Mainland China".  


During his fellowship at the HKIMR, he visited the Bank for International Settlements (BIS), the Bulgarian National Bank (BNB) and the Bank of Estonia in November 2001 to gain more understanding of how East European CBAs were prepared to join the Euro-zone. In the visit, he made a presentation called  “One Country, Two Monetary Systems” at the BIS on 6 November; at the BNB on 9 November; and at the Bank of Estonia on 14 November. To summarise the research findings of his fellowship, he presented a paper “From ‘One Country, Two Systems’ to Monetary Integration?” at the HKIMR on 30 January 2002.The following working papers were subsequently published:


“From “One Country, Two Systems”to Monetary Integration?”, HKIMR Working Paper No.15/2002, Hong Kong Institute for Monetary Research, September 2002.


“Optimum Currency Area for Mainland China and Hong Kong? Empirical Tests”, HKIMR Working Paper No.16/2002, Hong Kong Institute for Monetary Research, September 2002.


Prof. S.K. Tsang gave a talk "Currency Board Economics and the AEL Model" in the executive MBA programme of the Chinese University of Hong Kong on 22 January 2002, in which he discussed the impending collapse of the Argentine currency board system and the lasting lessons of the AEL model.

The following paper of team members was presented in the 2002 North American Summer Meeting of the Econometric Society held at Los Angeles, USA on 20 June - 24 June 2002: Chi-shing Chan (University of Hong Kong), Chor-yiu Sin and Yuk-shing Cheng, "Why is Currency Attack/Peg Prolonged?". Dr. C.Y. Sin attended the Meeting and presented the paper.

Prof. S.K. Tsang was invited to contribute a paper entitled "Currency Boards on the Way to Monetary Union: The Doubly Unplanned Case of Hong Kong" in Urmas Sepp and Martti Randveer  (editors ), Alternative Monetary Regimes in Entry to EMU, Bank of Estonia, November  2002. The book was a collection to commemorate the 10th Anniversary of the re-establishment of the Bank of Estonia.


Seminars and Research Papers on Currency Boards

Several seminars on currency boards were held in 2001-2002 at the Economics Department of the HKBU. The papers, together with other relevant ones posted in the internet, are available for download and links, at the web page It would be periodically updated.


Second Biennial Conference of HKEA

Prof. S.K. Tsang organised and chaired Session G " Financial Crisis, Policy Reponses and Reforms" of the Second Biennial Conference of the Hong Kong Economic Association, 16-17 December 2002, HKBU, Hong Kong. Members of the team presented the following papers at the conference:

Dr. Chan Chi-shin (JCTW Consultancy), Dr. Sin Chor-yiu and Dr. Cheng Yuk-shing, "Why Is Currency Attack/Peg Prolonged".

Dr. Yue Ma and Prof. S.K. Tsang, "How a Currency Board Fixes the Exchange Rate in a Crisis"

Dr. Yue Ma and Prof. S.K. Tsang,  "The Impact of External Balance on Money Supply and Inflation in China" (with Prof. Y.Y. Kueh of Lingnan University).


The strengthening of the HK Dollar from late September 2003

Due to a number of internal and external factors, the market exchange rate of the Hong Kong dollar strengthened from 23 September 2003 onwards. Prof. S.K. Tsang commented on the phenomenon in a press interview with Ming Pao and in the following short pieces:

"The strengthening of the Hong Kong dollar: A few observations" (1/10/03)

"Buffers for the link: A graphical note" (15/10/03)


Completion of the FRA

Members of the team were of the view that the FRA had accomplished its objectives and further research on relevant issues could be carried out without the need for a focused programme. Hence the FRA was terminated in December 2003.