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.
2-1
Focus on:



2-2
Evolution of the International Monetary System
Current Exchange Rate Arrangements
Fixed versus Flexible Exchange Rate Regimes
Evolution of the
International Monetary System





2-3
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: 1973Present
Bimetallism: Before 1875



2-4
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.
Classical Gold Standard:
1875-1914

During this period in most major countries:



2-5
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.
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


2-7
War crisis – there occurred instability in the price
of gold
Attempts were made to restore the gold standard
Bretton Woods System:
1945-1972




2-8
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.
Bretton Woods System:
1945-1972



2-9
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.
Bretton Woods System:
1945-1972
British
pound
German
mark
French
franc
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.


2-11
Central banks were allowed to intervene in the
exchange rate markets
Gold was abandoned as an international reserve
asset.
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
1.
2.
3.
1.
2.
3.
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.
4.
5.
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.
6.
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.



2-14
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. 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
United States