At one level, the current enthusiasm for hard pegs spring from a lack of enthusiasm for the ability of developing countries to build institutions and govern themselves soundly. But if the assessment of developing countries limited capacity for sound policy-making is empirically correct, this undermines the whole case for hard pegs, Velasco points out. For, not even the most enthusiastic advocate of currency boards would deny that they require soundly supervised banks and prudent fiscal policies. And the literature is littered with calls for strengthening bank supervision and eliminating budget deficits before adopting hard pegs. But both these are technically taxing and politically troublesome.
Financial supervision is always hard, and globalization and innovation have made it much more so.
The financial crashes in recent years in Japan, and the Scandinavian countries could be traced back to poor regulation. And the near collapse of the hedge fund, Long-Term Capital Management in the summer of 1998 revealed a gaping hole in regulatory arrangements covering Wall Street. There can be no doubt that supervising banks is as technically demanding, if not more so, than implementing monetary policy. And the political constraints are just as large, as we learn from the uproar that inevitably follows attempts to close insolvent banks or make good on earlier promises of no government bailouts. The dilemma facing those who attempt to design policy institutions for developing countries is stark.