Tony Latter: Why blame the peg? Speech by Mr Tony Latter, Deputy Chief Executive of the Hong Kong Monetary Authority, at a luncheon of the American Chamber of Commerce in Hong Kong, 12 March 2002. *  *  *  Introduction When things aren't going too well, it's natural to look for scapegoats. In the case of the Hong Kong economy, the pegged exchange rate certainly gets its fair share of that treatment. What is the basis for complaints about the peg, and how far are they justified? Before examining some of the complaints, however, let us review the monetary policy background. Monetary policy It is widely accepted that the duty of monetary policy - and that embraces exchange rate policy - is to provide that monetary environment which is most conducive to long-term growth and prosperity of the economy. This is seen to imply a desire for stable monetary conditions, but there is scope for judgement as to how this stability should be defined. The majority of regimes focus on internal purchasing power and thus aim for low and stable domestic inflation. Thus, the practice of inflation targeting has now become quite widespread and well understood. This requires an active monetary policy, necessarily impacting on domestic interest rates and money market liquidity; and, at least in the strictest form of targeting, it inevitably involves some exchange rate flexibility, even if not an entirely free float.
Summing up Back in 1983 when the peg was installed, I recall being asked whether it was the government's intention that the arrangement should be permanent, or in what circumstances a change would be contemplated. I said then simply that the peg was for the time being the most appropriate monetary anchor for Hong Kong. I would give very much the same answer today. Our peg is not a fixed rate that is supported by or dependent on discretionary intervention. It is a rulebased currency board system which imposes a particular discipline of adjustment through interest rate channels and domestic prices. It enjoys widespread support from international observers both in official circles and more widely. This is not just people being nice to us and choosing not to say anything which might rock the boat, although there may be one or two of them. Rather it reflects an appreciation of the unique features of a currency board structure and the benefits which it has brought over 18 years, as well as an appreciation of the distinctive characteristics of the Hong Kong economy. The main distinctive characteristics to which I allude are the following: the flexibility in costs and prices, as discussed earlier; the extreme openness of the economy in terms of both trade and capital flows; the constitutional commitment, through the Basic Law, to support the free movement of capital and not to operate exchange controls; and the soundness of the banking sector.