Question

(a) Apparently Hong Kong's linked exchange rate system has an automatic adjustment mechanism,. However, a substantial selling of Hong Kong dollars create problem to the linked exchange rateand the banking system. Why? Explain in detail. (12 mark)

(b) Is monetary policy or fiscal policy more effective under a fixed exchange rate system? Explain your answer. ( 13 marks)

Answer 1

(a) Apparently Hong Kong's linked exchange rate system has an automatic adjustment mechanism,. However, a substantial selling of Hong Kong dollars create problem to the linked exchange rateand the banking system. Why?

In 1863 the Hong Kong Government declared the silver dollar – then a kind of international currency – to be the legal tender for Hong Kong, and in 1866 began issuing a Hong Kong version of the silver dollar. The silver standard turned into the premise of Hong Kong's money related framework until 1935, while, amid a world silver emergency, the administration declared that the Hong Kong dollar would be removed the silver standard and connected to the pound sterling at the rate of HK$16 to the pound.1 Under the Currency Ordinance of 1935, banks were required to surrender to the Exchange Fund (which was put resources into sterling resources) all silver bullion held by them against their banknote issues in return for declarations of obligation. These endorsements were the lawful sponsorship for the notes issued by the note-issuing banks under what progressed toward becoming, as a result, a money board framework. The note-issuing banks were obliged to buy the testaments to back consequent increments in their note issue with sterling. In June 1972 the British Government chose to glide the pound sterling. The Hong Kong dollar was then connected quickly to the US dollar, first at the rate of HK$5.65 to the US dollar, and afterward, from February 1973, at HK$5.085. But, from June 1972, the note-issuing banks were allowed to purchase certificates of indebtedness with Hong Kong dollars. In November 1974, against a weakening US dollar, the Hong Kong dollar was allowed to float freely.

Hong Kong’s central bank said on Thursday it has confidence in the financial hub’s more than three-decade old peg to the U.S. dollar, even as it continued to intervene to prop up the currency and as interbank rates jumped to a 10-year high.

The Hong Kong Monetary Authority (HKMA) said its ongoing activities in the managing an account framework have been smooth and in accordance with desires subsequent to mediating in U.S. exchange as the Hong Kong dollar over and over hit the feeble end of its exchanging band.

"We see that the task in the market has been smooth and deliberate, and the market's trust in the capacity of the HKMA to keep up the solidness of the Hong Kong dollar is extremely solid and furthermore exceptionally solid trust in the Linked Exchange Rate System," said Howard Lee, vice president official of the HKMA, alluding to the city's cash peg.

"The sum and the degree of surges would depend especially on market opinion and furthermore the market see," he included.

Lee said he had not seen huge short-selling of Hong Kong dollars.The HKMA has now mopped up HK$51.33 billion of Hong Kong dollars from the foreign exchange market since last Thursday in its first intervention since 2015.

The Hong Kong dollar is pegged at 7.8 to the U.S. dollar however can exchange somewhere in the range of 7.75 and 7.85. Under the money peg, the HKMA is obliged to intercede when the Hong Kong dollar hits 7.75 or 7.85 to keep the band flawless.

The money exchanged at 7.8475 against the U.S. dollar at 0343 GMT while a key loaning rate that could push up obtaining costs moved to new highs.

The three-month interbank rate in Hong Kong HIHKD3MD=, which impacts contract rates, hit its most elevated since 2008, edging up to 1.33661 percent.