The paper examines the sources of macroeconomic instability in Hong Kong under the linked exchange rate regime. A prototype IS-LM model is estimated, with adaptation to the restrictions posed by the US dollar peg that has been in place in Hong Kong since 1983. Among all external and internal factors of instability examined, local Hong Kong interest rate is found to have a dominant effect on real GDP, price and money supply. Over the long run, however, the US interest rate is the driving force behind the Hong Kong interest rate. Foreign inflation also affects Hong Kong's domestic demand and price stability, and domestic demand in itself also acts as a significant factor, although it is not as influential as the Hong Kong interest rate and import price. Furthermore, Hong Kong's sound banking system has helped to create a stable currency demand environment for its economy, in spite of the fact that most Hong Kong residents hold both domestic and foreign currencies simultaneously The methodology and findings of the paper seem to provide a tenable framework for future research toward understanding the financial and monetary transmission mechanism in Hong Kong, and for improving the exchange rate regime.
Ma, Y., Kueh, Y. Y., & Ng, R. C. W. (2004). Macroeconomic instability in Hong Kong: Internal and external factors (CPPS Working Papers Series no.149). Retrieved from Lingnan University website: http://commons.ln.edu.hk/cppswp/100