RECENT PERFORMANCE OF THE HONG KONG DOLLAR LINKED EXCHANGE RATE SYSTEM

This paper reviews the performance of the Hong Kong dollar Linked Exchange Rate system since the introduction of the three refinements to it in May 2005. It presents an analytical framework which argues that, in a fully credible exchange rate target zone regime, the spot exchange rate normally stays inside the band but does not have a natural tendency to converge towards the centre of the zone. While a certain level of interest rate differential between the Hong Kong dollar and the US dollar may persist, it should not grow significantly larger than what is implied by the width of the Convertibility Zone. Judged against this framework, the developments since May 2005 point to increased credibility of the refined Linked Exchange Rate system.