International Monetary

System
 International Monetary System refers to the institutional arrangements that
countries adopt to govern exchange rates.
 The International Monetary System consists of elements such as laws, rules,
agreements, institutions, mechanisms and procedures which affect foreign
exchange rates, BOP adjustments, international trade and capital flows.
Features of a good monetary system

Adjustment

Stability and
Confidence

Liquidity
Exchange Rate Regimes (Developments in
International Monetary System)

Flexible
Inter-war Bretton Woods
Bimetallism Gold Standard Exchange Rate
Years(1914 – System (1945 -
(Before 1875) (1870 – 1913) regime (1973 –
1944) 1972)
till date)
Bimetallism: Before 1875

 A “double standard” in the sense that both gold and silver were used as money.
 The exchange rates among currencies were determined by either their gold or
silver contents
 Gresham’s Law implied that it would be the least valuable metal that would tend
to circulate.
The Gold Standard, 1870-1913

 In the early days gold was used as a storage of wealth and as a medium of
exchange
 Each country should set a par value for its currency in terms of gold and then try
to maintain this value
 Gold was measured as per ounce
 1 ounce = 31.1035gms
The Gold Standard, 1870-1913
 Fixed Rate System
 The world economy operated under a system of fixed dollar exchange
rates between the end of World War II and 1973, with central banks
routinely trading foreign exchange to hold their exchange rates at
internationally agreed levels.
 During this period in most major countries:
 Gold alone was assured of unrestricted coinage
 There was two-way convertibility between gold and national currencies at a stable ratio.
 Gold could be freely exported or imported.
The Gold Standard, 1870-1913

 For example, if the dollar is pegged to gold at U.S.$20.67 = 1 ounce of gold, and
the British pound is pegged to gold at £4.2474 = 1 ounce of gold, it must be the
case that the exchange rate is determined by the relative gold contents:

$ 20.67/ounce of Gold
£4.2474/ounce of Gold
$4.86656/ £
The Gold Standard, 1870-1913

 Highly stable exchange rates under the classical gold standard provided an
environment that was conducive to international trade and investment.
 Misalignment of exchange rates and international imbalances of payment were
automatically corrected by the price-specie-flow mechanism.
Decline of the Gold Standard

 When Inflation increases in particular country, the currency losses its

competitiveness in the market
 Imports being greater than exports let to a decline in the confidence of the
currency
 Many times gold was withdrawn from reserves and shipped abroad to pay for
imports
 With less gold at home, the country was forced to reduce its money supply
Decline of the Gold Standard

 With less gold at home, the country was forced to reduce its money supply
 This resulted in a slow down in economic activity, high interest rates, recession,
reduced national income and increased unemployment.
 This led to chaos in many countries including US and UK because of higher
inflation.
The Inter-war Years, 1914-1944

 Exchange rates fluctuated as countries widely used “predatory” depreciations of

their currencies as a means of gaining advantage in the world export market.
 Attempts were made to restore the gold standard, but participants lacked the
political will to “follow the rules of the game”.
 The result for international trade and investment was profoundly detrimental.
The Bretton Woods System, 1945-1972

 Named as 1944 meeting of 44 nations 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 IMF and the World Bank(IBRD).
The 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.
The Bretton Woods System, 1945-1972

German
British mark French franc
pound

r Par P
a
P lue Va a r
Value lu
Va e
U.S. dollar

Pegged at $35/oz.
Gold
Collapse of Bretton Woods (1971)

 U.S. high inflation rate

 U.S.$ depreciated sharply.
 Smithsonian Agreement (1971) US$ devalued to 1/38 oz. of gold.
 1973 The US dollar is under heavy pressure, European and Japanese
currencies are allowed to float
 Flexible exchange rates declared acceptable
 Gold abandoned as an international reserve
The Smithsonian Agreement

 From August-December 1971, most of the major currencies were permitted to

fluctuate.
 The US dollar fell in value against a number of major currencies.
 Several countries imposed trade and exchange controls
 It was feared that it might limit the international commerce.
 To solve this, the world trade leading countries, called the “Group of Ten”
produced the Smithsonian agreement on Dec 18, 1971.
The Smithsonian Agreement

 The agreement established a new set of parity rates which were called central
rates because they lacked the approval of the IMF.
 Unfortunately the agreement failed to reduce speculation.
 It came to an end in March 1973 because most of the “group ten” countries
allowed their currencies to float according to market forces.
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 to iron out
unwarranted volatilities.
 Gold was abandoned as an international reserve asset.
 Non-oil-exporting countries and less-developed countries were given greater
access to IMF funds.
Current Exchange Rate Arrangements
(IMF Classifications)
 Free Float
 The largest number of countries, about 48, allow market forces to determine
their currency’s value.
 Managed Float
 About 25 countries combine government intervention with market forces to
set exchange rates.
 Pegged to another currency
 Such as the U.S. dollar or euro (through franc or mark).
 No national currency
 Some countries do not bother printing their own, they just use the U.S. dollar.
For example, Ecuador, Panama, and El Salvador have dollarized.
Alternative Exchange Rate Systems:
Managed Float (“Dirty Float)
 Market forces set rates unless excess volatility occurs, then, central bank
determines rate by buying or selling currency. Managed float isn’t really a
single system, but describes a continuum of systems
 Smoothing daily fluctuations
 “Leaning against the wind” slowing the change to a different rate
 Unofficial pegging: actually fixing the rate without saying so.
 Target-Zone Arrangement: countries agree to maintain exchange rates
within a certain bound What makes target zone arrangements special is
the understanding that countries will adjust real economic policies to
maintain the zone.
 “Timeline”
1945
1960
The International Bank for
Speculative Capital
Reconstruction and Development was
Flows and Crises
established. Also know as the World
Bank

July 1944
The representatives of 44 countries International Monetary
met at Bretton Woods, New Early 1970’s
Fund
Hampshire. Agreed to renew the Economic crises were massive,
(IMF) was form
gold-exchange standard. Bretton The Bretton Woods structure of fixed
Woods system was born. exchange rates was brought down
US Dollar was pegged
to gold at$35 an ounce
 “Timeline”
Bretton Woods System High inflation and some Stagflation
August 15, 1971, President Richard ended worldwide
M. Nixon announced that the
United States would no longer From $3 to $12 per
redeem gold at $35 per ounce barrel
1973-1975
First Oil Shock

Worldwide inflation and the Second Oil Shock 1979 -1980

transition to Floating rates

From $13 to $32 per

US speeds up it monetary Inflation abroad as foreign central banks
barrel
growth under the Floating purchase the reserve currency to maintain their
exchange rate system exchange rates and expand their money supplies
in the process
IMF

 The IMF is an organization of 186 countries (Kosovo being the 186th, as of June
29, 2009)
 Headquarters at Washington D.C., U.S.A.
 IMF is the central
institution of
International monetary
system
IMF

 At the 2009 G-20 London summit, it was decided that the IMF would require
additional financial resources to meet prospective needs of its member countries
during the ongoing global crisis.
 As part of that decision, the G-20 leaders pledged to increase the IMF's
supplemental cash tenfold to $500 billion, and to allocate to member countries
another $250 billion via Special Drawing Rights.
IMF

Functions
 Foster global monetary cooperation
 Secure financial stability
 Facilitate international trade
 Promote high employment
 Promote sustainable economic growth
 Reducing poverty
 World Bank

The World Bank is an international financial institution that provides

leveraged loans to poorer countries for capital programs with a goal of
reducing poverty.
 Headquarters in Washington, D. C. , U.S. A.
 World Bank
 The WorldBank differs from the World Bank Group, in that the World
Bank comprises only two institutions:
 International Bank for Reconstruction and Development(IBRD)
 International Development Association (IDA)
Whereas the latter incorporates these two in addition to three more:
 International Finance Corporation (IFC)
 Multilateral Investment Guarantee Agency(MIGA)
 International Centre for Settlement of Investment Disputes(ICSID)