Question

Zimbabwe adopted the greenback as its official currency in response to hyperinflation, I was reading that Iceland was Considering adopting the Canadian $. What arrangements does a country have to make to adopt another countries currency? What is a central banks role as a lender-of-last resort? How does a country manage it's monetary policy in this situation?

Answer 1

Foreign Currencies circulate in all economies so there is always some available. I country can PEG its currency to another currency, but as far as I know, it cannot actually successfully use a currency of another country as its own primarily because it has no control then over the amount of currency that would be available. Countgries have pegged their currency to that of another country, which means that the exchange rate is not allowed to vary at all. So the central bank of that country just increase of decrease the amount of its own currencies to keep the exchange rate constant. By so doing, the country is tied to the other economy in such a way that it loses any control over its own economy and cannot engage in what we refer to as Monetary policy.

As lender of last resort, the central bank has the obligation to lend money to the banking system of the country if there is a panic or other economic disaster looming. As in our own country of the U.S., in 2007, the Federal Reserve expanded the money supply to help keep the banking system in the U.S. solvent and to prevent any more bank bankruptcies. The Federal Government also lent them money for the same reason. That is what some refer to as the "bank bailout" scenario of 2007. Most economists agree that this was necessary but some do not. wmw