Mr Ricketts, HKD
GAANVAATAN
FROM: S H Broadbent
DATE : 29 November 1991
cc : Mr Bayne
Sir J Coles Mr Burns (or)
lie
HONG KONG: THE LINKED EXCHANGE RATE SYSTEM
1. I have already commented orally on the points raised in your minute of 14 November, but I wanted to reflect on the basis of some further work we have been doing and on various papers on inflation which the Financial Secretary has recently sent to me.
2.
I still have not seen Lord Marlsford's comments. But I can imagine three ways in which the link could be said to be "responsible" for inflation, although only one of them involves "importing" inflation:
(a) over time, Hong Kong's real exchange rate (ie its nominal exchange rate against a basket of currencies adjusted for the difference between Hong Kong and world inflation rates) is bound to rise, as the corollary of faster growth than elsewhere in the world and of moving lower value added production elsewhere (ie to China). This adjustment can occur either through Hong Kong's prices growing faster than those elsewhere, or by upward movements in the nominal exchange rate, or through some combination of the two. Adopting a fixed exchange rate effectively means that it is the former, although we should note that the link with the US dollar, which in the long term tends to depreciate against the generality of currencies, means rather more inflation in Hong Kong than would otherwise be required.
(b)
that Hong Kong cannot interest rates above a interest rates).
At
In the short term, the link means tighten monetary policy (ie raise level determined by prevailing US the moment, this means that real interest rates in Hong Kong are significantly negative.
With the economy beginning to boom, this clearly tends to exacerbate the inflation, most noticeably in the property market; and
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