Hong Kong is a Special Administrative Region within China, and the Basic Law provides that the Hong Kong SAR and Mainland China are fiscally independent. This paper demonstrates that because fiscal transfers are not permissible Hong Kong SAR and the Mainland need to have two separate currencies, if each is to achieve full employment and fiscal budget balance. An analytical framework is provided in the paper supporting the argument that Hong Kong is in the position to adopt a “full employment budget balance fiscal policy” and to adopt an enlightened monetary policy that aims at bringing aggregate demand to the full employment level. For Mainland China, because full employment budget balance is unlikely to be achievable in the short term and because of its weaker monetary position, a system of linking the RMB to a basket of currencies is recommended as providing both a clear monetary rule and a superior degree of flexibility relative to linking with a key currency at a fixed exchange rate.
Ho, L. S. (1997). A long term monetary strategy for Hong Kong and China (CAPS Working Paper Series No.67). Retrieved from Lingnan University website: http://commons.ln.edu.hk/capswp/36