1. Chapter 18 The International Monetary System
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

2. Learning Objectives
Revisit the determination of the exchange rate by briefly examining the polar extremes of freely flexible and fixed exchange rates.
Explain and evaluate the various kinds of exchange rate systems that trading nations use.
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

3. Learning Objectives (cont.)
Describe the gradual reform of the international monetary system, including the three different exchange rate systems that the nations of the world have used.
Discuss the recent history of, and changes in, Australia's exchange rate.
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

4. Exchange Rate Systems Two types of exchange rate system:
Flexible or floating exchange rates
the exchange rate is determined by demand and supply
Fixed exchange rates
government intervention in the foreign exchange market offsets the changes in exchange rate caused by the demand and supply factors
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

5. Freely Floating Exchange Rates
Depreciation and Appreciation
Depreciation in the exchange rate is an increase in the number of units of a country’s currency required to buy a single unit of some foreign currency
Appreciation is a reduction in the number of units of a country’s currency required to buy a single unit of some foreign currency
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

6. Flexible Rates and the Balance of Payments
Flexible exchange rates automatically adjust so as to eliminate balance of payments deficits or surpluses
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

7. Adjustments under Flexible, Fixed and the Gold StandardP D1 S1 D0 3 2 1
Dollar price of one pound C X B D1 A S1 D0 Q
Pounds
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

8. Flexible Exchange Rates
Disadvantages of floating exchange rates:
Uncertainty and diminished trade
uncertainty on prices due to movements in the exchange rate
Terms of trade
Instability in the macroeconomic environment
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

9. Fixed Exchange Rates
Nations have often fixed or pegged the exchange rate to overcome the disadvantages from floating exchange rates
Fixed exchange rates require adequate reserves to accommodate periodic balance of payment deficits
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

10. Fixed Exchange Rates (cont.)
To maintain a fixed exchange rate a country may enact protectionist trade policies to increase net exports
Exchange controls: rationing
restricting imports to the amount of foreign exchange earned by exports
Domestic macroeconomic adjustments
use fiscal and monetary policies to adjust GDP to a level consistent with the fixed exchange rate
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

11. The Gold Standard
A system under which the value of a nation’s monetary unit was backed by gold rather than fiat
Gold standard conditions
define the monetary unit in terms of a certain quantity of gold
fixed relationship between stock of gold and the domestic currency
allow gold to be freely exported and imported
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

12. The Gold Standard (cont.)
Gold flows
Domestic macro adjustments
Advantages of gold standard
reduces uncertainty and risk
automatically corrects balance of payments deficits or surpluses
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

13. The Gold Standard (cont.)
Disadvantages of gold standard
nations must accept domestic adjustments in the form of higher unemployment or inflation
countries must have sufficient reserves of gold
Demise of the gold standard
during the Depression years of the 1930s
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

14. Bretton Woods Monetary System
Bretton Woods conference 1944
Adjustable peg system of exchange rate emerged
a system by which members of the IMF were obligated to define their monetary units in terms of gold (or US dollars), establishing par rates of exchange between the currencies of all other members, and to keep their exchange rates within 1 per cent of these par values
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

15. IMF and Pegged Exchange Rates
Stabilisation funds
suppliers of both foreign and domestic monies and gold held with the central bank or treasury for the purpose of intervention in the foreign exchange market to maintain the par value of the exchange rate
IMF credit
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

16. Bretton Woods Monetary System (cont.)
Fundamental imbalances: adjusting the peg
Demise of the Bretton Wood
Dilemma: dollars and the deficits
Emergence of floating rates
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

17. The ‘Managed Float’
An exchange rate system where central banks buy and sell foreign exchange to smooth out short-run or day-to-day fluctuations in rates
Encourages international trade and finance, while allowing for trend or long-term exchange rate flexibility to correct fundamental payments disequilibria
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

18. The ‘Managed Float’ (cont.)
Liquidity and special drawing rights
special drawing rights are bookkeeping entries at the IMF, available to IMF members in proportion to their IMF quotas, that may be used to settle payments deficits or satisfy reserve needs in place of foreign exchange or gold
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

19. The ‘Managed Float’: An Evaluation
Arguments for managed float
Trade growth
Managing turbulence
Arguments against
Volatility and adjustment
Reinforcement of inflation
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

20. Exchange Rate History: Australia
Setting exchange rates in the 1970s
Pegged to the US dollar
Pegged to the trade-weighted index
The floating of the exchange rate (1983)
Floating and the current account crisis
Recovery during the late 1980s
The early 1990s and the 1990 recession
The late 1990s and the Asian crisis
Into the 2000s
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

21. END OF CHAPTERS
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University