The sudden wave of newly independent monetary authorities in Eastern Europe, and recent experiments in Latin America, have caused a resurgence of interest in the idea that currency boards might have advantages over fully fledged central banks in achieving currency stability. In Discussion Paper No. 1040, Research Fellow Patrick Honohan examines the Irish case, claiming that, although in 1943 a central bank had assumed control of note issue, Ireland continued to operate a de facto currency board linking the Irish pound with sterling until the 1970s. This makes it one of the more successful currency board experiences.

Honohan evaluates the &nbspbenefits and costs of the system. As benefits, the regime seems to have provided an adequate amount of seigniorage and made the expected contribution to financial and macroeconomic stability: inflation and interest rates were largely driven by those in the UK. There are also two types of costs. One concerns the perpetuation of trading links with a market which did not share its post-war dynamism, a cost that is difficult to quantify. The other is relatively small: the system's inflexibility in dealing with shocks. Partly because of the large additional foreign reserves held by the private banking system and partly because of the weakness of the `master' currency, sterling, the inflexibility of the Irish system was not severely tested.

The author concludes that despite the fairly satisfactory record of the Irish arrangement, it is not necessarily an example to be followed. Few countries can have as natural a choice of partner currency as Ireland. Furthermore, as a country's financial and fiscal system matures, the apparent advantages of a currency board may eventually wear thin, and the flexibility of regular central banking seem seductive.

Currency Board or Central Bank? Lessons from the Irish Pound's Link with Sterling, 1928–79
Patrick Honohan

Discussion Paper No. 1040, October 1994 (IM)