Latvia is considering adopting a convertible currency which would be highly backed and which would be administered by a currency board. The problem is that with a tiny proportion of national income generated by trade with convertible currency countries this would require a huge initial undervaluation of the new domestic currency (the Lat), which would be highly stagflationary. The introduction of a bi-paper standard, with the Lat as a fully backed second currency circulating in parallel with the rapidly inflating Latvian ruble, avoids these costs. The advantages of such a system for revolutionary banking sector reform are also described.

---

June 1992     Paper Number CEPDP0083