An Assessment of the Sustainability and Desirability of a Currency Board Arrangement, with Special Reference to Bosnia and Herzegovina

The purpose of this research is to investigate whether the currency board arrangement (CBA) in Bosnia and Herzegovina (BH) is sustainable and desirable by assessing its credibility and its effect on the economy. A CBA is a rigid monetary regime under which a country fixes its exchange rate to some foreign currency and maintains 100 percent backing of its monetary base with foreign exchange. In 1997, BH adopted a CBA in its endeavour to achieve macroeconomic stabilisation in the post-war period. As BH is now moving towards accession to the EU, an important question concerns the desirability and sustainability of its CBA in the short to medium term. Since there is no long data span for estimating the effects of the CBA in Bosnia and Herzegovina in the empirical analyses other countries are also investigated. Using a survey database for Central and South-Eastern European countries the biprobit analysis finds that, other things being equal, a CBA is likely to increase the credibility of the monetary authority, even in periods of crisis, since the period for which credibility is investigated is the period of the global financial crisis and the euro crisis (2009-2011). The results also suggest that CBAs are more likely to increase the credibility of the monetary authority the lower the level of trust in government and the worse the perceptions about the economic situation in a country. In order to assess the desirability of a CBA its effect on macroeconomic performance is investigated. The results of panel analyses of 25 transition countries with a range of different monetary/exchange rate regimes, suggest that a CBA has a negative effect on inflation, over and above that due to the fixed exchange rate and high degree of central bank independence. The investigation of the effect of CBA on the subjective evaluation of national economic performance suggests a negative effect of CBA, presumably due to the strictness of the monetary authority under a CBA. The important additional finding is that this negative effect becomes significantly smaller the lower the trust in government. This again implies that a CBA is more effective in a low trust environment, where it is more likely to be viewed as necessary for stabilisation. Since the political situation in Bosnia and Herzegovina is still complex and uncertain, the benefits of maintaining its CBA appear to be higher than the costs and the regime is sustainable and desirable in the short to medium run.