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Transcript of International Monetary System.pdf
The International Monetary System
11-2
What Is The International Monetary System?
Ø International monetary system - the institutional arrangements that govern exchange rates Ø A floating exchange rate system exists when a
country allows the foreign exchange market to determine the relative value of a currency
Ø A pegged exchange rate system exists when a country fixes the value of its currency relative to a reference currency
Ø A 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. dollar
Ø A fixed exchange rate system exists when countries fix their currencies against each other at some mutually agreed on exchange rate
11-3
What Is The International Monetary System?
Ø From 1880s until today v 1880s – 1914 : Gold Standard v 1918 – 1939 : Interwar years v 1944-1971 : Bretton Woods System v 1976 – Today : New exchange rate System
11-4
What Was The Gold Standard? Ø The Gold Standard refers to a system in
which countries peg currencies to gold and guarantee their convertibility Ø in the 1880s, most nations followed the gold
standard Ø $1 = 23.22 grains of “fine” (pure) gold
Ø the gold par value refers to the amount of a currency needed to purchase one ounce of gold
11-5
Ø For example, suppose • 1 unit of currency A = 10 ounce of gold • 1 unit of currency B = 20 ounce of gold Then
EA/B = 20 ÷ 10 = 2 = price of currency B in terms of currency A
11-6
Ø BOP < 0 ⇒ outflow of gold ⇒ the central bank reacts by reducing its domestic credit holding ⇒ MS↓ • ⇒ P↓ ⇒ EP*/P ↑ ⇒ CA↑ ⇒ BOP>0 ⇒ inflow of gold ⇒ MS↑ ⇒ P↑ ⇒ EP*/P ↓ ⇒ CA↓ ⇒ BOP = 0
• ⇒ i↑ ⇒ capital inflow ⇒ BOP = 0
Ø The great strength of the gold standard was that it contained a powerful mechanism for achieving balance-of-payment equilibrium by all countries (i.e. BOP = 0).
11-7
Why Did The Gold Standard Make Sense?
Ø The gold standard worked well from the 1880s until 1914 Ø but, many governments financed their World War I
expenditures by printing money and so, created inflation
Ø People lost confidence in the system
11-8
Interwar years: 1918 - 39
Ø During WWI, the gold standard was abandoned by many countries.
Ø 1919: US returned to the gold standard ← little inflation during the war
Ø 1925: Britain returned to the gold standard at the parity prevailing before the war
11-9
Britain’s case MS↑ during and after the war ⇒ P↑ So, Britain had to have contractionary monetary
policies ⇒ unemployment↑ ⇒ economic stagnation in 1920s ⇒ London’s decline as int’l financial center ⇒ Pound holders lost confidence in pounds and
began converting their pound to gold → a run on British gold reserves
⇒ 1931 Britain was forced to abandon the gold standard
11-10
US’s case
Ø 1931: A run on US gold → 15% drop in US gold holdings
Ø 1933: US left the gold standard. Ø 1934: US returned to the gold standard at
$35 per ounce (devaluation from $20.67).
11-11
1930s
Ø Great depression ⇒ Int’l economic disintegration
Ø A period of competitive devaluations: In trying to stimulate domestic economies by increasing exports, country after country devalued.
Ø FX controls Ø Trade barriers → int’l monetary warfare
11-12
What Was The Bretton Woods System?
Ø In 1944, representatives from 44 countries met at Bretton Woods, New Hampshire, to design a new international monetary system that would facilitate postwar economic growth
Ø Under the new agreement Ø a fixed exchange rate system was established Ø all currencies were fixed to gold, but only the U.S.
dollar was directly convertible to gold Ø devaluations could not to be used for competitive
purposes Ø a country could not devalue its currency by more than
10% without IMF approval
11-13
German mark British
pound French franc
U.S. dollar
Gold
Pegged at $35/oz.
Par Value
What Was The Bretton Woods System?
11-14
What Institutions Were Established At Bretton Woods?
Ø The Bretton Woods agreement also established two multinational institutions
1. The International Monetary Fund (IMF) to maintain order in the international monetary system through a combination of discipline and flexibility
2. The World Bank to promote general economic development Ø also called the International Bank for Reconstruction
and Development (IBRD)
11-15
Why Did Bretton Woods System Collapse?
Ø Bretton Woods worked well until the late 1960s Ø It collapsed when huge increases in welfare programs
and the Vietnam War were financed by increasing the money supply and causing significant inflation Ø other countries increased the value of their currencies
relative to the U.S. dollar in response to speculation the dollar would be devalued
Ø However, 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 point Ø the U.S. dollar came under speculative attack
11-16
Why Did Bretton Woods System Collapse?
Ø 1958-65: Private capital outflows from US Ø 1965-68: Johnson Administration
The bad US macroeconomic policy package caused considerable damage to the US economy and the int’l monetary system. • Involvement in the Vietnam conflict • “Great Society” program ⇒ G↑ ⇒ Deficit↑ ⇒ MS↑ ⇒ P↑ & CA↓ (stagflation)
11-17
Why Did Bretton Woods System Collapse?
Ø 1971: US CA deficit ⇒ massive private purchase of DM ⇒ Bundesbank intervened in FX market by buying huge amount of dollars, then it gave up and allowed the DM to float.
Ø August 1, 1971: Nixon’s announcement Ø Stop to sell gold for dollars to foreign central banks Ø 10% tax on all imports until revaluation of each
country’s currency against the dollars Ø Freeze on prices and wages.
11-18
Floating Exchange Rates: 1973 - Ø Speculative attacks on the pound and the lira Ø 1972: Britain allowed the pound to float. Ø 1972-73: speculators began selling dollars
massively. Ø 1973: US devalued the dollar again ($42.22 per
ounce of gold). Ø By March 1973 major currencies were all
floating.
11-19
What Was The Jamaica Agreement?
Ø A new exchange rate system was established in 1976 at a meeting in Jamaica
Ø The rules that were agreed on then are still in place today
Ø Under the Jamaican agreement Ø floating rates were declared acceptable Ø gold was abandoned as a reserve asset Ø total annual IMF quotas - the amount member
countries contribute to the IMF - were increased to $41 billion – today they are about $300 billion
11-20
What Has Happened To Exchange Rates Since 1973?
Ø Since 1973, exchange rates have been more volatile and less predictable than they were between 1945 and 1973 because of Ø the 1971 and 1979 oil crises Ø the loss of confidence in the dollar after U.S.
inflation in 1977-78 Ø the rise in the dollar between 1980 and 1985 Ø the partial collapse of the EMS in 1992 Ø the 1997 Asian currency crisis Ø the decline in the dollar from 2001 to 2009
11-21
What Has Happened To Exchange Rates Since 1973?
Major Currencies Dollar Index, 1973-2010
11-22
A variety of ex rate system Ø Managed Floating: MA influences ex rates through
active FX market intervention Ø (Independently) Floating: the ex rate is market
determined. No FX intervention. Ø Currency Board: A legislative commitment to
exchange domestic currency for a specified foreign currency at a fixed ex rate.
11-23
A variety of ex rate system Ø Fixed Peg: The ex rate is fixed against a major
currency. Active intervention needed. Ø Crawling Peg: The ex rate is adjusted periodically in
small amounts at a fixed, preannounced rate. Ø Dollarization: The dollar circulates as the legal tender.
11-24
Which Is Better – Fixed Rates Or Floating Rates?
Ø Floating exchange rates provide 1. Independent macroeconomic policies. 2. Countries can choose different inflation rates. 3. Automatic trade balance adjustments
Ø But, a fixed exchange rate system 1. Provides monetary discipline 2. Minimizes speculation 3. Reduces uncertainty
11-25
What Type of Exchange Rate System Is In Practice Today?
Ø Various exchange rate regimes are followed today Ø 14% of IMF members follow a free float policy Ø 26% of IMF members follow a managed float system Ø 22% of IMF members have no legal tender of their own Ø the remaining countries use less flexible systems such as
pegged arrangements, or adjustable pegs Ø Countries with a pegged exchange rate system peg the
value of its currency to that of another major currency Ø Countries using a currency board commit to converting
their domestic currency on demand into another currency at a fixed exchange rate
11-26
What Type of Exchange Rate System Is In Practice Today?
Exchange Rate Policies of IMF Members
11-27
Choice of Peg or Float Ø Peg
Ø Small size (GDP) Ø Open economy Ø Harmonious inflation rate Ø Concentrated trade
Ø Float Ø Large size Ø Closed economy Ø Divergent inflation rate Ø Diversified trade