1. Chapter 18 Changes in the Monetary Base

2. Central Bank Balance Sheets Main Liabilities of Federal Reserve 1.Currency 2.Deposits of Banks at Fed Main Assets of Federal Reserve 1.Government Securities 2.Discount Window Loans 3.Foreign Reserves Main Liabilities of HKMA 1.Certificates of Indebtedness 2.Aggregate Balances 3.Exchange Fund Notes Main Assets of HKMA 1.Discount Window Loans 2.Foreign Reserves 3.Domestic Equities

3. The Fed announces a target interest rate in US interbank market. The Fed target interest rate can be changed. The Fed changes monetary base primarily through Open Market Operations (the purchase or sale of US Treasury bills). The HKMA announces a target fixed exchange rate. The HKMA target exchange rate has not been changed in 17 years. The HKMA changes the monetary base primarily through Foreign Exchange intervention (the purchase or sale of US dollars)

4. HKMA Liabilities

5. HK$ Money Supply

6. Money Supply In General –M1 = Currency in Circulation [C] + Demand Deposits [D] –M2 = M1 + N [Savings Deposits + “Small” Time Deposits] + MM [Liquid Money Market Instruments including “Small” NCD’s] –M3 = M2 + LTD [“Large” Time Deposits and NCD’s] Small and Large are defined in different ways in different countries. In HK, small means liabilities of licensed banks and large means liabilities of RLB’s and DTC’s.

7. Chapter 19 Organization of Central Banks

8. Hong Kong Monetary Authority Central Bank: The government agency that overseas the banking system and is responsible for the amount of money and credit supplied in Hong Kong. HKMA formed in 1993 with merger of Exchange Fund and Commissioner of Banking to perform role of the central bank. 1.Regulation of the Banking System 2.Operation of the System of Payments 3.Control of the Monetary Base

9. Payment Settlement System 1.Hong Kong Dollar System All banks hold clearing balances at the HKMA to settle interbank claims. [Real Time Gross Settlement System] A check for $1000, drawn on Bank A, is submitted to HKMA by Bank B. HKMA transfers $1000 from the clearing balance of Bank A to clearing balance of Bank B. [ Note: Total clearing balance remains unchanged] Before 1993, Clearing Balances held at HSBC. 2.US Dollar System US Dollar chief currency of international financial system, but US Payment system shutdown during most of HK business day. HKMA operates US dollar payment system to encourage trade in US dollar securities in HK.

10. Linked Exchange Rate System HK money supply set to maintain a constant exchange rate between the HK dollar and the US dollar. To implement fixed exchange rate, HKMA operates currency board system. Key principle of currency board: New Hong Kong dollar monetary liabilities can only be issued if HKMA increases its holdings of US dollars.

11. Exchange Fund Exchange Fund consists of the reserves (mostly US dollar) used to back the HK dollar and increase confidence in the exchange peg. In 1999, balances of the Land fund (revenues from sales of land) were merged with the exchange fund. The financial secretary controls the exchange fund, but its day-to-day management is delegated to HKMA.

12. History of Hong Kong Monetary System 1863: 1935 – Silver Standard: Hong Kong banks issue dollar notes backed by silver bullion. 1935: 1972 – Sterling Standard: Hong Kong banks issue dollar notes backed by UK pounds. 1972: 1974 – Fixed Exchange Rate with US dollar 1974:1983 – Floating Exchange Rate 1984: Today - Linked Exchange Rate System

13. Is HKMA Independent from Government? Chief Executive of the HKMA chosen by HK Government Chief Executive, however, terms of replacement are vague. Exchange Fund controlled by Financial Secretary. Existence & Convertibility of HK dollar written into the Basic Law. Decision to continue or abandon peg lies with HK government.