INTERNATIONAL MONETARY SYSTEM

The International Monetary System institutional framework within which: International payments are made. The movement of capital is accommodated. Exchange rates are determined. The International Monetary System 2-1

Focus on: Evolution of the International Monetary System Current Exchange Rate Arrangements Fixed versus Flexible Exchange Rate Regimes 2-2

Evolution of the International Monetary System Bimetallism: Before 1875 - SILVER & GOLD Classical Gold Standard: 1875-1914 - GOLD Interwar Period: 1915-1944 - GOLD Bretton Woods System: 1945-1972 - $ pegged to GOLD The Flexible Exchange Rate Regime: 1973-Present 2-3

Bimetallism: Before 1875 A “double standard” in the sense that both gold and silver were used as money. Some countries were on the gold standard, some on the silver standard, some on both. Both gold and silver were used as international means of payment and the exchange rates among currencies were determined by either their gold or silver contents. 2-4

Classical Gold Standard: 1875-1914 During this period in most major countries: Gold alone was assured of unrestricted coinage Gold could be freely exported or imported. The exchange rate between two country’s currencies would be determined by their relative gold contents. 2-5

Classical Gold Standard: 1875-1914 For example, if the dollar is pegged to gold at U.S. $30 = 1 ounce of gold, and the British pound is pegged to gold at £6 = 1 ounce of gold, it must be the case that the exchange rate is determined by the relative gold contents: $30 = 1 ounce of gold = £6 $30 = £6 $5 = £1 2-6

Interwar Period: 1915-1944 War crisis – there occurred instability in the price of gold Attempts were made to restore the gold standard 2-7

Bretton Woods System: 1945-1972 44 nations joined at Bretton Woods, New Hampshire. The purpose was to design a postwar international monetary system. The goal was exchange rate stability without the gold standard. The result was the creation of the International Monetary Fund and the World Bank. 2-8

Bretton Woods System: 1945-1972 Under the Bretton Woods system, the U.S. dollar was pegged to gold at $35 per ounce and other currencies were pegged to the U.S. dollar. Each country was responsible for maintaining its exchange rate within ±1% of the adopted par value by buying or selling foreign reserves as necessary. The Bretton Woods system was a dollar-based gold exchange standard. 2-9

Bretton Woods System: 1945-1972 German mark British pound French franc Par Value Par Value Par Value U.S. dollar Pegged at $35/oz. Gold 2-10

The Flexible Exchange Rate Regime: 1973-Present. Flexible exchange rates were declared acceptable to the IMF members. Central banks were allowed to intervene in the exchange rate markets Gold was abandoned as an international reserve asset. 2-11

What is Exchange Rate? Exchange rate is the price at which the national currency is valued in relation to a foreign currency. Exchange rate affects the price of imports when expressed in domestic currency and the price of exports when expressed in foreign currency Exchange rate serve as a indicator for external competitiveness

Current Exchange Rate Arrangements FLEXIBLE or FREE FLOAT SYSTEMS FIXED EXCHANGE RATE SYSTEMS HYBRID EXCHANGE RATE SYSTEMS Managed Floating Rate Systems - set a “implicit target value” Target Zone Systems - set a “target range” or “exchange rate band” Crawling Pegs - for currencies which frequently get devalued – this system sets fixed rate changes in a pre-determined manner instead of in an arbitrary way. Fixing to a Basket of Currencies - Dollarization - the decision to give up your own currency and adopt another currency. countries that dollarized include Ecuador and Panama. Currency Controls - sustain unrealistic exchange rates by combining a fixed exchange rate system with restrictions on who has access to acquire foreign currency from the Central Bank. 2-13

Current Exchange Rate Arrangements 1. FREE FLOAT or FLEXIBLE In a flexible exchange rate system, the value of the currency is determined by the market by the interactions of thousands of banks, firms and other institutions seeking to buy and sell currency for purposes of transactions clearing, hedging, arbitrage and speculation. The largest number of countries Eg. US,UK,JAPAN,AUSTRALIA,CANADA Benefits of a free float system: Easier External Adjustment - market determined Demand & Supply National Policy Autonomy Limitations of a free float system: Rate uncertainty – may affect trade 2-14

2. MANAGED FLOAT A managed floating rate system is a hybrid of a fixed exchange rate and a flexible exchange rate system. In a country with a managed floating exchange rate system, the central bank becomes a key participant in the foreign exchange market. the central bank has an implicit target value for their currency: it intervenes in the foreign exchange market by buying and selling domestic and foreign currency to keep the exchange rate close to this desired implicit value. It is also known as a dirty float. About 45 countries Eg. SINGAPORE,INDIA,RUSSIA Thailand central bank wants to keep the value of the Baht close to 25 Baht/$. tolerate small fluctuations in the exchange rate say from 24 to 26

3. PEGGED CURRENCY OR FIXED Currency pegging is - fixing the exchange rate of a currency by matching it’s value to the value of another single currency ( $ or euro or Yen) or to a basket of other currencies, or to another measure of value, such as gold or silver. Adopted by small countries and those economies which are based on exports . Eg. Countries that primarily export oil or have direct trade with the U.S. Benefits to a developing country: useful for small economies where external trade forms a large part of their GDP Pegging is also used as a means to control inflation

Limitations as reference value rises and falls, so does the currency pegged to it. No national autonomy and hence no safeguard during crisis Devaluation would occur in the long-run Eg. CURRENCY PEGGED TO $ ( around 17 countries) Netherlands Antillean guilder, Aruban florin, Jordanian dinar, Bahrain's dinar, Lebanon's pound, Oman's rial, Qatar's rial, the Saudi riyal, Emirati dirham, Maldivian rufiyaa,…….

Questions What is a International Monetary System? What are its functions? Write a brief note on the evolution of the present International Monetary System. What is an Exchange Rate? What are the different forms of exchange rate? Evaluate a fixed vs flexible exchange rates. What are the criteria for a good International Monetary System? ANS: IMS should provide a. liquidity, adjustment and confidence.

countries does not have its own currency British Virgin Islands East Timor Ecuador El Salvador Marshall Islands Northern Mariana Islands Palau Panama Turks and Caicos Islands