2 The International Monetary System Chapter 11The International Monetary System
3 What Is The International Monetary System? International monetary system - the institutional arrangements that govern exchange ratesA floating exchange rate system exists when a country allows the foreign exchange market to determine the relative value of a currencyA pegged exchange rate system exists when a country fixes the value of its currency relative to a reference currencyA dirty float exists when a country tries to hold the value of its currency within some range of a reference currency such as the U.S. dollarA fixed exchange rate system exists when countries fix their currencies against each other at some mutually agreed on exchange rate
4 What Was The Gold Standard? The gold standard refers to a system in which countries peg currencies to gold and guarantee their convertibilityin the 1880s, most nations followed the gold standard$1 = grains of “fine” (pure) goldthe gold par value refers to the amount of a currency needed to purchase one ounce of goldLO1: Describe the historical development of the modern global monetary system.
5 Why Did The Gold Standard Make Sense? The great strength of the gold standard was that it contained a powerful mechanism for achieving balance-of-trade equilibrium by all countriesThe gold standard worked well from the 1870s until 1914but, many governments financed their World War I expenditures by printing money and so, created inflationPeople lost confidence in the systemBy 1939, the gold standard was dead
6 What Was The Bretton Woods System? In 1944, representatives from 44 countries met at Bretton Woods, New Hampshire, to design a new international monetary system that would facilitate postwar economic growthUnder the new agreementa fixed exchange rate system was establishedall currencies were fixed to gold, but only the U.S. dollar was directly convertible to golddevaluations could not to be used for competitive purposesa country could not devalue its currency by more than 10% without IMF approvalLO1: Describe the historical development of the modern global monetary system.
7 What Institutions Were Established At Bretton Woods? The Bretton Woods agreement also established two multinational institutionsThe International Monetary Fund (IMF) to maintain order in the international monetary system through a combination of discipline and flexibilityThe World Bank to promote general economic developmentalso called the International Bank for Reconstruction and Development (IBRD)LO2: Explain the role played by the World Bank and the IMF in the international monetary system.
8 Why Did The Fixed Exchange Rate System Collapse? Bretton Woods worked well until the late 1960sIt collapsed when huge increases in welfare programs and the Vietnam War were financed by increasing the money supply and causing significant inflationother countries increased the value of their currencies relative to the U.S. dollar in response to speculation the dollar would be devaluedHowever, because the system relied on an economically well managed U.S., when the U.S. began to print money, run high trade deficits, and experience high inflation, the system was strained to the breaking pointthe U.S. dollar came under speculative attackLO1: Describe the historical development of the modern global monetary system.
9 What Was The Jamaica Agreement? A new exchange rate system was established in 1976 at a meeting in JamaicaThe rules that were agreed on then are still in place todayUnder the Jamaican agreementfloating rates were declared acceptablegold was abandoned as a reserve assettotal annual IMF quotas - the amount member countries contribute to the IMF - were increased to $41 billion – today they are about $300 billionLO1: Describe the historical development of the modern global monetary system.
10 What Has Happened To Exchange Rates Since 1973? Since 1973, exchange rates have been more volatile and less predictable than they were between 1945 and 1973 because ofthe 1971 and 1979 oil crisesthe loss of confidence in the dollar after U.S. inflation inthe rise in the dollar between 1980 and 1985the partial collapse of the EMS in 1992the 1997 Asian currency crisisthe decline in the dollar from 2001 to 2009LO1: Describe the historical development of the modern global monetary system.
11 What Has Happened To Exchange Rates Since 1973? Major Currencies Dollar Index,LO1: Describe the historical development of the modern global monetary system.
12 Which Is Better – Fixed Rates Or Floating Rates? Floating exchange rates provideMonetary policy autonomyAutomatic trade balance adjustmentsBut, a fixed exchange rate systemProvides monetary disciplineMinimizes speculationReduces uncertaintyLO3: Compare and contrast the differences between a fixed and floating exchange rate system.
13 What Type of Exchange Rate System Is In Practice Today? Various exchange rate regimes are followed today14% of IMF members follow a free float policy26% of IMF members follow a managed float system22% of IMF members have no legal tender of their ownthe remaining countries use less flexible systems such as pegged arrangements, or adjustable pegsCountries with a pegged exchange rate system peg the value of its currency to that of another major currencyCountries using a currency board commit to converting their domestic currency on demand into another currency at a fixed exchange rateLO4: Identify exchange rate regimes that are used in the world today and why countries adopt different exchange rate regimes.
14 What Type of Exchange Rate System Is In Practice Today? Exchange Rate Policies of IMF Members
15 What Is The Role Of The IMF Today? Today, the IMF focuses on lending money to countries in financial crisisThere are three types of financial crises:A currency crisisBrazil 2002A banking crisisA foreign debt crisisGreece and Ireland 2010
16 How Has The IMF Done?By 2010, the IMF was making loans to 68 countries all of which require tight macroeconomic and monetary policyHowever, critics worrythe “one-size-fits-all” approach to macroeconomic policy is inappropriate for many countriesthe IMF is exacerbating moral hazardthe IMF has become too powerful for an institution without any real mechanism for accountabilityHowever, in recent years, the IMF has started to change its policies and be more flexibleurged countries to adopt fiscal stimulus and monetary easing policies in response to the global financial crisisLO5: Understand the debate surrounding the role of the IMF in the management of financial crises.
17 What Does The Monetary System Mean For Managers? Managers need to understand how the international monetary system affectsCurrency management - the current system is a managed float - government intervention can influence exchange ratesBusiness strategy - exchange rate movements can have a major impact on the competitive position of businessesCorporate-government relations - businesses can influence government policy towards the international monetary systemLO6: Explain the implications of the global monetary system for currency management and business strategy.