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Monetary System. Relationship between monetary system and foreign exchange rates Historical development Fixed vs floating exchange rates Role of the IMF.

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Presentation on theme: "Monetary System. Relationship between monetary system and foreign exchange rates Historical development Fixed vs floating exchange rates Role of the IMF."— Presentation transcript:

1 Monetary System

2 Relationship between monetary system and foreign exchange rates Historical development Fixed vs floating exchange rates Role of the IMF and World Bank Implications for managers

3 International Monetary System Currency exchange rates depend on the structure of the international monetary system In 2003 of all IMF members currencies – Only 19% were free floating – 25% were managed float – 8% were adjustable peg – 22% were fixed peg – 4% were fixed by a currency board – 22% were not currency of their own (use Euro, US Dollar)

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5 Evolution of the International Monetary System Gold Standard: currencies pegged to gold value – Convertibility guaranteed – By 1880 most on gold standard – Balance of trade equilibrium for all countries Value of exports should equal value of imports Flow of gold used to make up differences – Abandoned in 1914 Failed resumption after WWI Great Depression

6 Bretton Woods ( ) 44 countries met to design a new system in 1944 Established: International Monetary Fund (IMF) and World Bank – IMF: maintain order in monetary system – World Bank: promote general economic development – Fixed exchange rates pegged to the US Dollar – US Dollar pegged to gold at $35 per ounce – Countries maintained their currencies ± 1% of the fixed rate; buy/sell own currency to maintain level

7 The Role of the IMF IMF maintained exchange rate – discipline National governments had to manage inflation through their money supply – flexibility Provides loans to help members states with temporary balance-of-payment deficit; –Allows time to bring down inflation –Relieves pressures to devalue Excessive drawing from IMF funds came with IMF supervision of monetary and fiscal policies – Allowed to 10% devaluations and more with IMF approval 187 members by 2003

8 The Role of the World Bank World Bank (IBRD) role (International Bank for Reconstruction & Development) – Refinanced post-WWII reconstruction and development – Provides low-interest long term loans to developing economies The International Development Agency (IDA), an arm of the bank created in 1960 – Raises funds from member states – Loans only to poorest countries – 50 year repayment at 1% per year interest

9 Collapse of Bretton Woods Devaluation pressures on US dollar after 20 years – Lyndon Johnson policies Vietnam war financing Welfare program financing – Nixon ended gold convertibility of US dollar in 1971 – US dollar was devalued and dealers started speculating against it for further devaluation – Bretton Woods fixed exchange rates abandoned in January 1972

10 Jamaica Agreement 1976 Floating rates declared acceptable Gold abandoned as reserve asset; – IMF returned gold reserves to members at current prices – Proceeds placed in trust fund to help poor nations – IMF quotas – member country contributions – increased; membership now 182 countries – Less-develop, non-oil exporting countries given more access to IMF IMF continued its role of helping countries cope with macroeconomic and exchange rate problems

11 – Monetary policy autonomy – Trade balance adjustments helped The Case for Fixed Exchange Rates – Monetary discipline – Speculation limited – Uncertainty reduced – Trade balance adjustment effects on inflation controlled Who is right? Case for Floating Exchange Rates

12 Recent Activities and the IMF Mexican Crisis 1995 Russian Ruble crisis1995 Asian crisis 1997/1998 – Events The investment boom Excess capacity The debt bomb Expanding imports The crisis How does the IMF achieve results? – Inappropriate policies? – Moral Hazard? – Lack of accountability?

13 Managerial Implications Currency management – Currency market does not always work as expected – Government intervention – Speculative activity Business strategy – Movements in exchange rates are difficult to predict – Forward market is imperfect predictor of exchange rate movements – Forward exchange rate market covers risk for months not years – Maintenance of strategic flexibility required Disperse manufacturing Outsource – Corporate-government relations


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