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Distinguished Research Fellow of the Institute of Global Economics and Finance of The Chinese University of Hong Kong Professor Joseph Yam today (12 June 2012) published an academic paper captioned “The Future of the Monetary System of Hong Kong” in which he outlines his findings to strengthen the monetary system of Hong Kong so that it continues to serve the public interest in the best possible manner.

Professor Yam nursed the Linked Exchange Rate System (LERS) from its establishment in October 1983 for over a quarter of a century.  He “had a hand” in establishing the Hong Kong Monetary Authority (HKMA) in April 1993 and had served as Chief Executive of the HKMA for sixteen and half years until his retirement in September 2009.

He said that the monetary system of Hong Kong, characterized by the LERS has served the city well for almost thirty years but a fixed exchange rate cannot be an end in itself.

“With the changing external environment, the need to maintain the status of Hong Kong as an international financial centre in accordance with the requirement of the Basic Law and the changing aspirations of the people of Hong Kong, there is a need to address the questions as to whether the monetary system of Hong Kong, as currently structured, can continue to serve the public interest of Hong Kong in the best possible manner, and if not what modifications should be introduced so that it can”, he said.

In different sections of the paper, Professor Yam outlined in detail the legal, monetary, technical and political issues to be considered in shaping the future of the monetary system of Hong Kong.  He explained that “the legal framework on which the monetary system is based, and monetary policy determined, allows the adoption of traditional central banking practices of exercising discretionary monetary management to achieve traditional monetary policy objectives”, such as low inflation, low unemployment and stable and sustainable economic growth.  He disclosed that, in strengthening the LERS over the years, monetary reform measures have also been discreetly introduced to put the HKMA “in as effective a position as any central bank to control the supply and the price of the domestic monetary base – a technical capability essential to the exercising of discretionary monetary management”.

Separately, he expressed the opinion that “the long term sustainability of the status of Hong Kong as an international financial centre and the continued maintenance of monetary and financial stability in Hong Kong require a monetary system that allows currency risks to be managed by overseas investors and fund raisers using the financial markets of Hong Kong through providing a financial infrastructure that allows transactions to be conducted in a currency of their choice”.

“It is unrealistic to expect the monetary system of a jurisdiction with seven million people, if it keeps its domestic orientation, with the domestic currency continuing predominantly to perform the roles of money, to continue meaningfully as an international financial centre to serve the needs of international financial intermediation between a jurisdiction with 1.3 billion people and the rest of the world, and maintain monetary and financial stability at the same time”, he said.

On possible refinements to the monetary system, if discretionary monetary management is to be introduced, Professor Yam mentioned various longer term possibilities:

• Unifying the two different Convertibility Undertakings for the two elements of the monetary base, namely, the bank notes in circulation and the Aggregate Balance
• Widening meaningfully (in one go or by steps) or simply removing the Convertibility Zone or turning it into a corridor for the exchange rate (against the US dollar or the renminbi or an undisclosed basket of currencies), with the width, the slope and the centre of the corridor subject to periodic review
• Doing away with the exchange rate target or zone, and focus in managing the domestic monetary conditions in order to achieve the defined monetary policy objectives.

Professor Yam, however, emphasized that, as he has retired for almost three years, his “addressing the future of the monetary system of Hong Kong at this time should not necessarily imply the need for change”. 

Research paper of Professor Yam can be downloaded from the website of the Institute of Global Economics and Finance of The Chinese University of Hong Kong at http://www.igef.cuhk.edu.hk/.