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Post-Conflict Currency Reform
Currency reform is often a major challenge for countries recovering from violent conflict. Post-conflict economies have undertaken a variety of different currency reforms. When Somaliland broke away from Somalia, reformers introduced an entirely new currency as a symbol of new statehood. In Rwanda, the old national currency was replaced by a new national currency. By contrast, some post-conflict countries choose to adopt a foreign currency as legal tender. For example, in Montenegro the Deutsche mark was circulated as legal tender along with the Yugoslav dinar, and in East Timor the U.S. dollar became the only legal tender because most international payments in East Timor were denominated in U.S. dollars and in the absence of an East Timorese central bank, it was administratively convenient to dollarize.
Many post-conflict economies lack policy credibility. By dollarizing or euroizing, post-conflict economies may improve their credibility. As an alternative to outright adoption of a foreign currency, currency boards allow for a post-conflict country to circulate a national currency while simultaneously improving policy credibility because a currency board pegs the national currency to the exchange rate of the euro, the dollar or some basket of international currencies. A currency board may be superior to dollarization because currency board countries still benefit from seigniorage revenue and enjoy greater policy flexibility than they would under outright dollarization.57
57 Tony Addison, Alemayehu Geda, Philippe Le Billon and S. Mansoob Murshed, Financial Reconstruction in Conflict and Post-Conflict Economies, UNU/WIDER Policy Paper (September 2001).
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Nonetheless currency boards restrict policy choice. For example, central banks under currency board regimes may not act as lenders of last resort because the money supply is restricted by the level of foreign exchange reserves. Therefore adoption of a currency board regime may expose the banking sector to greater risk of crisis. Bosnia-Herzegovina’s currency board regime may have contributed to its recent banking crisis.58 The policy limitations of currency board and dollarization regimes are particularly dangerous for post-conflict economies because their public resources are typically strained by reconstruction expenditures, making it difficult for the government to provide failing banks with aid.
In summary, the literature on post-conflict currency reform suggests three important policy considerations. First, a currency may carry important symbolic value for a new state or a new regime emerging from conflict. Second, a post-conflict country may use currency reform to gain badly-needed policy credibility by dollarizing or pegging its national currency to a currency with greater credibility such as the euro or the dollar through a currency board. Finally, experience teaches the desirability of retaining some policy flexibility to ward off banking crises because crises may be especially devastating in post-conflict economies where public resources are already strained.

http://www.law.harvard.edu/programs/pifs/pdfs/kirsten_malm.pdf