Brief history and Some important
concepts
The International monetary system,
World Bank, Exchange regime,
Eurocurrency, Eurodollar, The birth of
Euro. Etc.
New institutions in the post-war
International monetary system
• International Monetary Fund (IMF)
• The International Bank for Reconstruction and
Development (World Bank)
2
International Monetary Fund (IMF)
– The International Monetary Fund was created to:
• Help countries defend their currencies against cyclical,
seasonal, or random occurrences
• Assist countries having structural trade problems if
they promise to take adequate steps to correct these
problems
• Special Drawing Right (SDR) is the IMF reserve asset,
currently a weighted average of four currencies
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The role of IMF
Managing director of IMF Christine Lagarde
interview on StGallen Symposium: 2nd , May
http://t.co/AXwcb24Zyy
• 3 points for recovering world economy:
Monetary policy combined with fiscal consolidation
where it is needed at the right pace
Unleash entrepreneurial potential
Q: Banking union? What lies ahead? Would EU
in its current form survive? Watch the video.
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The role of World Bank
• The World Bank helped fund post-war
reconstruction and has since then supported
general economic development
” We are not a bank in the ordinary sense but
a unique partnership to reduce poverty and
support development.”
President of WB:
Jim Yong Kim
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Five Institutions, One Group
The World Bank Group organization chart
The International Bank for Reconstruction
and Development (IBRD)
The International Centre for
Settlement of Investment
Disputes (ICSID)
The Multilateral
Investment
Guarantee Agency
(MIGA)
The International
Development
Association (IDA)
The International Finance
Corporation (IFC)
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The World Bank mission: reduce
poverty worldwide
Among others, combating Financial Crisis.
Moving swiftly, the Bank Group expands and
speeds up lending, assistance and advice to
hard-hit developing countries.
In fiscal year 2009, the Bank Group committed
nearly $60 billion to support countries affected
by the crisis, a 54% increase over the previous
year, and a record high for the institution.
Watch a video of Jim Yong Kim at Georgetown University:
http://www.youtube.com/watch?v=2ebIoJOkEWs
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Exhibit 3.1 The Evolution of Capital Mobility
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Eurocurrency and Libor
• Eurocurrencies (p27-p29)
– domestic currencies of one country deposited in
another country.
(consists of Eurodollar market. Euroyen, Euroeuro,
Eurosterling)
Eurodollar: U.S.-dollar denominated deposits at
foreign banks or foreign branches of American banks
locating outside of the United States
– Eurodollars escape regulation by the Federal
Reserve Board.
3-9
History of the International Monetary
System
• Eurocurrency Interest Rates: Libor
– In the Eurocurrency market, the reference rate of
interest is the London Interbank Offered Rate
(LIBOR)
This rate is the most widely accepted rate of interest
used in standardized quotations, loan agreements,
and financial derivatives transactions
– There are Pibor, Fibor Mibor (before 1999), Stibor
(Stockholm Interbank Offered Rate) and now
Euribor
3-10
History of the International Monetary
System
• Fixed Exchange Rates (1945-1973)
– The currency arrangement negotiated at Bretton Woods
and monitored by the IMF worked fairly well during the
post-WWII era of reconstruction and growth in world trade
– The US dollar became the main reserve currency held by
central banks
– Eventually, the heavy overhang of dollars held by
foreigners resulted in a lack of confidence in the ability of
the US to met its commitment to convert dollars to gold
3-11
History of the International Monetary
System
– The lack of confidence forced President Richard Nixon to
suspend official purchases or sales of gold by the US
Treasury on August 15, 1971
– This resulted in subsequent devaluations of the dollar
– Most currencies were allowed to float to levels determined
by market forces as of March, 1973
3-12
History of the International Monetary
System
• An Eclectic Currency Arrangement (1973 –
Present)
– Since March 1973, exchange rates have become
much more volatile and less predictable than they
were during the “fixed” period
– There have been numerous, significant world
currency events over the past 30 years
3-13
Exhibit 3.2 The IMF’s Exchange Rate Index of the
Dollar
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Exhibit 3.3 World Currency Events, 1971-2011
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Exhibit 3.3
World
Currency
Events,
1971-2011
(cont.)
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Exhibit 3.6 The U.S. Dollar/Euro Rate,
1999 - 2011
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US dollar/Euro ($/€) 04,01,1999-13,05,2013
source: ECB
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JPY vs. Euro rate (04,01,1999-13,05,2013)
source: ECB
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CNY vs. EUR (2005-2013)
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The IMF’s Exchange Rate
Regime Classifications
• The International Monetary Fund classifies all
exchange rate regimes into eight specific categories
–
–
–
–
–
–
–
–
Exchange arrangements with no separate legal tender
Currency board
Other conventional fixed peg
Pegged exchange rates within horizontal bands
Crawling pegs
Exchange rates within crawling pegs
Managed floating
Independent floating
3-21
The IMF’s Exchange Rate
Regime Classifications
Exhibit 3.4 presents the IMF’s regime classification methodology
in effect since January 2009
• Category 1: Hard Pegs
– Countries that have given up their own sovereignty over monetary
policy
E.g., dollarization or currency boards
• Category 2: Soft Pegs
– AKA fixed exchange rates, with five subcategories of classification
• Category 3: Floating Arrangements
– Mostly market driven, these may be free floating or floating with
occasional government intervention
• Category 4: Residual
– The remains of currency arrangements that don’t well fit the previous
categorizations
Exhibit 3.4 IMF Exchange Rate Classifications
Exhibit 3.4 IMF Exchange Rate
Classifications (cont.)
Fixed Versus Flexible
Exchange Rates
• A nation’s choice of currency regime to
follow depends on many variables:
–
–
–
–
–
inflation,
unemployment,
interest rate levels,
trade balances, and
economic growth.
• The choice between fixed and flexible rates
may change over time as priorities change.
3-25
Fixed Versus Flexible Exchange Rates
 Fixed rate regime has advantages and
disadvantages:
 stability in international prices
 inherent anti-inflationary nature of fixed prices
 but:
 Need for central banks to maintain large
quantities of hard currencies and gold to defend
the fixed rate
 Fixed rates can become incompatible with
economic fundamentals as time goes.
3-26
Emerging Markets
and Currency Regime Choices
 Currency board regime
a country’s central bank commits to back its monetary base (its
money supply) entirely with foreign reserves.
1 Argentina Peso=1 USD
 This means that a unit of domestic currency cannot be
introduced into the economy without an additional unit of
foreign exchange reserves being obtained first.
I.
Argentina moved from a managed exchange rate to a
currency board in 1991
II. In 2002, the country ended the currency board as a
result of substantial economic and political turmoil
3-27
Exhibit 3.8 The Currency Regime
Choices for Emerging Markets
3-28
Emerging Markets
and Regime Choices
• Dollarization is the use of the US dollar as the
official currency of the country.
– Panama has used the dollar as its official currency
since 1907
– Ecuador replaced its domestic currency with the
US dollar in September, 2000
Exhibit 3.7 shows Ecuadorian Sucre movement vs the U.S. Dollar prior
to Dollarization
3-29
Exhibit 3.7 The Ecuadorian Sucre/U.S. Dollar Exchange Rate,
November 1998-March 2000
Currency Regime Choices for Emerging
Markets
• Some experts suggest countries will be forced to extremes
when choosing currency regimes - either a hard peg or freefloating
(Exhibit 3.8)
• Three common features that make emerging market choices
difficult:
1.
2.
3.
weak fiscal, financial and monetary institutions
tendencies for commerce to allow currency substitution and the
denomination of liabilities in dollars
the emerging market’s vulnerability to sudden stoppages of outside
capital flows
The Euro:
Birth of a European Currency
• In December 1991, the members of the
European Union met at Maastricht, the
Netherlands to finalize a treaty that changed
Europe’s currency future.
• This treaty set out a timetable and a plan to
replace all individual ECU currencies with a
single currency: the euro.
View Funding fathers of Euro
(http://www.ecb.int/events/conferences/html/symposium_video.en.html)
3-32
The Euro:
Birth of a European Currency
• To prepare for the EMU, a convergence criteria was
laid out whereby each member country was
responsible for managing the following to a specific
level:
–
–
–
–
Nominal inflation rates
Long-term interest rates
Fiscal deficits
Government debt
• In addition, European Central Bank (ECB), was
established in Frankfurt, Germany.
3-33
Effects of the Euro
• The euro affects markets in three ways:
1. Cheaper transactions costs in the Euro
Zone
2. Currency risks and costs related to
uncertainty are reduced
3. Price transparency and increased pricebased competition
3-34
Exchange Rate Regimes: the future?
All exchange rate regimes must deal with the
tradeoff between rules and freedom (vertical
axis), as well as between cooperation and
independence (horizontal axis)
(see Exhibit 3.9)
Rule
s
independence
The pre WWI Gold Standard required
adherence to rules and allowed independence
The Bretton Woods agreement (and to a
certain extent the EMS) also required
adherence to rules in addition to cooperation
The present system is characterized by no
rules, with varying degrees of cooperation
Cooperation
Freedom
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3.9 The Trade-Offs Between Exchange Rate Regimes
Fixed exchange
rate
Independent
Currency board
Free floating
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