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THE ECONOMY
In the late 1970s, the inflation rate stayed at double-digit levels. Three factors were relevant during this period. First, the double-digit real growth rates of the economy for each year since 1976 resulted in a persistent imbalance with the aggregate demand for domestic resources being in excess of their supply. Second, the rate of world inflation accelerated sharply in 1979, resulting in a rapid rate of increase in import and export prices. Third, the growth rate of the money supply was faster than the growth rate of GDP in money terms. In 1982 the inflation rate, in terms of the Consumer Price Index (A), slowed down to 10.6 per cent reflecting the lower growth rate of the economy, and it remained at 10.0 per cent in 1983, largely as a result of the depreciation of the exchange rate of the Hong Kong dollar.
Economic Policy
Economic policy is to a certain extent dictated, and constrained, by the special circum- stances of the Hong Kong economy. Due to its small and open nature, the economy is very vulnerable to external factors, and government action to offset unfavourable external factors is often of limited effectiveness. The government is of the view that the allocation of resources in the economy is most efficient if left to market forces, and government intervention is kept to the minimum.
This basically free-enterprise system has contributed to Hong Kong's economic success. The narrowly-based tax structure with low tax rates provides incentives for workers to work and for entrepreneurs to invest. Both workers and entrepreneurs are highly motivated, given that all individuals have equal opportunity to pursue the goal of individual betterment and wealth accumulation. The primary role of the government is to provide the necessary infrastructure together with a stable legal and administrative framework conducive to economic growth and prosperity.
Monetary Policy
There are few monetary instruments available to the government for monetary policy purposes. From 1974 until October 1983, the Hong Kong dollar was a conventional floating currency and during this period the Exchange Fund's role in directly influencing the exchange rate through intervention in the foreign exchange market was limited at most to ironing out short-term fluctuations. In October 1983 the government made a fundamental change to the framework of monetary policy, involving a revised role for the Exchange Fund.
Against a background of continuing depreciation and increasing instability of the exchange rate of the Hong Kong dollar, particularly in September, the government decided with effect from October 17, 1983, to alter the arrangements for the issue and redemp- tion of the certificates of indebtedness issued by the Exchange Fund, which the two note- issuing banks are required to hold as cover for the issue of Hong Kong dollar banknotes. Previously these certificates were issued and redeemed against payments in Hong Kong dollars. Now payments are in US dollars at the fixed exchange rate of US$1 = HK$7.80. In practice, therefore, any rise in the note circulation has to be matched by a US dollar payment to the Exchange Fund and any fall in circulation is matched by a similar payment from the fund. The note-issuing banks in turn extend this fixed rate to all other banks in Hong Kong in respect of their note requirements.
Under this new arrangement, the forces of competition and arbitrage in foreign exchange dealings ensure that the market exchange rate stabilises at a level close to the fixed rate of US$1 = HK$7.80 without intervention by the Exchange Fund in the market.