KYAMBOGO UNIVERSITY

SCHOOL OF MANAGEMENT AND ENTREPRENEURSHIP

PROGRAMME ACCOUNTING, FINANCE AND MICROFINANCE
COURSE UNIT: BASIC MACROECONOMICS
COURSE CODE: AEC 1202
YEAR: ONE
SEMISTER: TWO

LECTURER’S NAME: DR. IBIN IBRAHIM DAMASANTE

TASK: GROUP COURSEWORK

GROUP MEMBERS
S/ NAMES REGISTRATION NUMBER SIGNATURE
NO
01 OCEN HERBERT 23/U/MFD/14567/GV
02 ANKUNDA PAPIUS 23/U/MFD/04055/PD
03 NABIRYE TINAH 23/U/MFD/09152/PD
04 SABIR INNOCENT 23/U/MFD/12441/PD
05 NIWAHA RYNAH 23/U/MFD/11200/PD
06 NYANGOMA LETICIA 23/U/MFD/11461/PD
07 ODONGO GODFFREY 23/U/MFD/11650/PD
08 IKILAI ANNA GRACE 23/U/MFD/05949/PD
09 NAKATO PAMELA GRACE 23/U/MFD/09585/PD
10 AMUTE PHILIP 23/U/MFD/03966/PD

QUESTIONS:
1a) With the help of illustrations, explain the relationship amidst interest rates, demand for and
supply of money.
b) Using good illustrations, explain the effects of expansionary monetary policy on interest rates.

1
2a) Uganda`s banking system comprises many commercial banks. Hajat Kulusumu Najjita a
business mogul and magnate in kampala city deposited £100,000 in Standard chartered bank.
Bank of Uganda has set a 5% cash reserve ratio for all commercial banks.

i) Using a very clear illustrations, discuss the process of credit creation.

a. Discuss the factors that may limit commercial banks from having unlimited
powers to create credit.

3a) Using a very good illustrations and examples where possible, discuss the modern growth
theories, clearly highlighting the features, implication and criticisms.

b) Show and explain the long run aggregate supply and the trend rate of growth.

4a) Discuss how the foreign exchange rate is determined and the different exchange rate regimes.

b) Discuss the history of international monetary system.

c) Using a clear illustrations, discuss the process of recording transactions under balance of
payment accounts.

2
1a) Money refers to anything accepted as a medium of exchange and it has value. The
relationships amidst interest rates, demand and supply of money is described by the theory of
market equillibrium. This theory suggest that the interest rates are determined by the interaction
between the demand for money and the supply of money in an economy.

Demand for money: The demand for money refers to the the amount of money individuals and
business want to hold for transactions and speculative purposes. The demand for money is
influenced by several factors including the level of income, the price, price level and the interest
rates.

When the interest is low: When the interest rate is low, the cost of borrowing money increases
therefore increasing the demand for money as people are willing to borrow money at lower
interest rate. So the demand for money could go up.

When the interest rate is high: When the interest rate is high, people may be less inclined to
borrow. This is because the cost of borrowing decreases, increasing the demand for money as
people are more willing to borrow at lower rates.

Money demand can be represented in graph as seen below.

interest rate

Quantity of money per period

Supply of money: The supply of money refers to the total amount of money available in an
economy. It is determined by the central banks through monetary policy measures such as open
market operations, reserve requirements, and discount rates.

3
Increase in the money supply: When the central banks implement expansionary monetary policy
such as buying government securities in the open market, it increases the money supply. This
leads to a rightward shift in the supply of money curve.

Decrease in the money supply: Conversely, when the central bank implement contractionary
monetary policy such as selling government securities in the open markets, it reduces the money
supply. This results in leftward shift in the supply of money curve.

Money supply can be represented in graph as below.

interest rate ms/p

i”

i` L(i,Y)

B A

Real money

Where ms/p represent the real money supply in terms of prices that prevailed in the base year.

The impact of interest rate on the money supply.Interest rate have a great effect on the money
supply in the economy, shaping the path of economic growth, inflation and the spending habits
of consumers and bussinesses.

Money market equillibrium: The equillibriun interest rate is determined by the intersection of
the demand for money and the supply of money curve in the money market.

If the interest rate is below the equillibriun level, the quantity of money demanded exceeds the
money supply. This creates an excess demand for money leading to upward pressure on interest
rates.

If the interest rate is above the equillibrium level, the quantity of money supplied exceeds the
money demanded. This creates an excess supply of of money leading to downward pressure on
interest rates.

4
A graph showing money market equilibrium.

ms/p

interest rate

i$ e

qm md

Real money

Here is an illustration of the relationship among interst rates, demand and supply of
money.

S2 S1

interest rate

r2

r1

Q2 Q1

Quantity of money

In the illustration, the equillibrium interest rate is determined at the intersection of the demand of
money (D) and the supply of money(S) curves. Changes in the demand or supply of money will
shift the respective curves leading to changes in the equilibrium interest rate.

b) Expansionary monetary policy refers to the actions taken by the central banks to stimulate
economic growth and increase the money supply. It involves measures such as buying
government securities, lowering reserves requirements and reducing the discount rates. The goal

5
of the expansionary monetary policy is to lower interest interest rate and encourage borrowing
and investment in the economy. The effects of expansionary monetary is as below.

Increase in money supply: Expansionary monetary policy involves increasing the money
supply. This is represented by the rightward shift in the supply of the money curve.

Decrease in the interest reate: With the increased money supply, the demand for money
intersects the new supply curve at a lower interest rate. This leads to a downward shift in the MS
curve from MS1 to MS2. As a result, the equilibrium interest rate decreases.

i$ Ms`/P$

i$` MS”P$

i$” B L(i$, Y§)

1 2
Real money

In this illustration, we have the interest rate on the vertical axis and the quantity of money
(realmoney) on the horizontal axis. The initial stage is represented by Ms`/P$ which depicts the
money market before the implementationof expansionary monetary policy.

The lower the interest rate resulting from the effects of the expansionary monetary policy have
several effects on the economy as seen below.

Increased investment and borrowing: Lower interest rates makes borrowing cheaper which
stimulates investments in businesses and encourages consumers to borrow foe purchases. This
can leads to increased business expansion, job creation and economic growth.

Increased consumption: Lower interest rates reduce the cost of borrowing for consumers
making it more affordable to finance purchases of homes, cars, and other goods and services.
This can boost consumers spending and overall economic activities.
6
Assets price increase: Lower interest rates can incentivize investors to move from fixed income
investments like bonds to riskier assets such as stocks and real estates. This increased demand for
assets can leads to higher asset prices, pottentially benefitting investors and wealth holders.

Pottential risks and limitations: While expansionary monetary policy can have positive effects
on the economy, there are some pottential risks and limitations to consider:

i. Inflationary pressure. A significant increase in the money supply can pottentially

leads to inflation in the growth in demand outpaces the growth in production. Central
banks need to carefully monitor inflationary pressures and adjust monetary policy
accordingly.
ii. Effectiveness at the zero lower bound. When the interest rates are already very low, it
may be challenging for further interest rates reductions to have a significant impact
on stimulating borrowing and investments. In such cases, central banks may resort to
unconventional monetary policy measures such as quantitative easing or forward. It is
important to note that the specific effects of expansionary monetary policy canvary
depending on the economic conditions, yhe responsiveness of borrowers and
investors to interest rates chnges, and other factors influencing the overall business
and consumers sentiments.

2a) Credit creation refers to the process by which commercial banks expand the money
supply through lending and creating new deposits. Here is a step by step illustrations of the
credit creation process:

Step 1: Initial deposit of Hajjat was £100,000 into the account of standard chartered bank. This
amount becomes part of the bank reserves.

Standard chartered bank`s reserves =£100,000

Step 2: Cash reserve requirement in uganda, banks are required to hold a certain percentage of
their deposits as cash reserves which is 5%

Standard chartered required reserves = 5% of £100,000 =5/100* £100,000 =£5000

Standard chartered bank`s excess reserve =£100,000-£5000 =£95,000

7
Step 3: Lending and creation of new deposits. A standard chartered bank can now lend a portion
of the excess reserves to borrowers. Let`s assume that the bank lend out £80,000 to borrowers.

The standard chartered bank`s excess reserves after lending =£95,000- £80,000 =£15000

Step 4: Loan recipients deposits: The businress receiving the loan deposits the $80,000 in it`s
account at another commercial bank which could be the same or a different bank.

Step 5: New deposit creation when the bank lends £80,000, it creates the borrowers account with
the amount. This creates a new deposit in the banking system.

Borrowers deposit = £80,000.

Following the 5% reserve requirement a new bank must hold $4000 (5% of $80,000) as reserve
and can lend out the remaining $76,000.

Step 6: Repeat of the process. This cycle continues as the $76,000 is lent out by the new bank,
deposited by borrowers into other accounts, and used as reserves for further lending by othetr
banks.

Step 7: multiplier effects. Through this process, the initial $100,000 deposited by Hajjat leads to
the creation of new loans and deposits, expanding the money supply in the economy beyond the
initial deposit amount.

It is important to note that the process of credit creation is more complex and involves
interactionsbetween multiple banks and their clients. The illustrations provided simplifies the
process for clarity.

b) Commercial banks do not have access to create credits due to several factors. Here are
some key limitations on their ability to create credit.

Higher reserve requirements: Central banks typically impose reserve requirements on

commercial bamks. These requirements mandate that banks holds a certain percentage of their
deposit as reserves, either in the form of cash or or as deposits with the central banks. Reserve
requirements aim to ensure that banks have sufficient fund to meet withdrawal demands from
depositors and maintain stability in the financial system. By holding reserves, banks have less
capacity to create new credit.

8
High capital requirements: Banks are also given capital adequacy requirements which specify
the minimum amount of capital they must maintain in relation to their risk- weighted assets.
Capital acts as a buffer against pottential losses and support the overal stability of banks.capital
adequacy regulations limit banks to leverage capital base to create credits.

Over regulations: Various prudential regulations are in place to ensure the safety and soundness
of the banking system. These regulations includes limit to exposure to some specifc sectors or
borrowers, restrictions on risky activities and requirements for risk management and reporting.
Such regulations are designed to mitigate risks and prevent excessive credit creations that could
lead to financialinstability.

Limited creditworthiness amongst clients: Banks have a responsibility to assess the

creditworthiness of the borrowers before extending loans. This involves evaluating factors such
as borrowers income, collaterals, credit history and ability to repay the loan.

Limited market demand for credit: The ability to create cresit is also influenced by the
demand for credit from the borrowers. Even if banks have the capacity to create create credit,
they may not find the sufficient creditworthy clients or may face unlimited demand for loans due
to economic conditions, market dynamics, or borrowers preference. The borrowers willingness to
take a loan plays an important role in the process of credit creation.

Monetary policy constraints: Commercial banks operate within framework of money policy set
by the central bank. The central banks influences the overall money supply and credit conditions
through measures such as adjusting interest rates, conducting open market operations, and
implementing macro[rudential policies. Monetary policy decision can influence the lending
capacity of banks and impact the overall credit creation n the country.

Interest rates on loans: High interest rates on loans leads to low demand for loans as borrowing
becomes expensive hence limiting credit creation.

Liquidity constraints: Banks need to have sufficient liquidity to meet the demand of depositors
and other obligations. If banks face liquidity shortages, they may be reluctant to extend
additional credits thus limiting credit creations.

9
International factors: Factors such as global economic conditions, exchange rate fluctuations
and international regulatory framework can also impact credit creation in commercial banks
particularly those with international operations.

Market confidence and sentiments: During periods of financial instability, market participants
may become more risk-averse leading to reduced credit creations as banks becomes more
cautions in lending.

Quality of collaterals. Banks often requires collaterals from borrowers to mitigate the risks of
defaults. If the quality of available collaterals declines or if there is a lack of acceptable
collaterals, banks may be reluctant to extend credit, limiting credit creations.

Bank profitability: The profitability of commercial banks can also impact credit creations. If
banks face financial challenges or their profitability is under pressure, they may be more cautious
to in extending credit to maintain their financial stability.

Competition: competition from other financial institutions and non bank lenders can limit a
bank ability to create credit. If other lenders are offering more attractive terms or taking on
riskier loans banks may struggle to compete and extend credits.

Technological and operational constraints: Bank`s capacity for credit creation maybe limited
by technological and operational constraints such as outdated system, inefficient processes or
cyber security risks which can hinder their abiluty to originate, process and manage loans
effectively.

It is important to note thatthese factors interact with each other and can vary accross countries
and regulatory frameworks. Additionally, the policies and practices of individual banks can also
influence the process of credit creations.

3a) Mordern growth theories are economic models that seek to explain the long term growth and
development of economies. They have evolved from various neoclassical growth theories by
incorperating additional factors factors and mechanisms that drives economic growth. The
following are the modern growth theories with their features, implications and criticisms:

Classical growth theory: This theory emerged in the 18th and 19th centuaries, laid the
foundation for understanding economic growth and development before the advent of modern

10
growth theory. The classical economists including Adam Smith, David Ricardo and Thomas
Multhus focus on the factors such as land, labour and the capital accumulation in explaining long
term economic growth.

Features:

Factors of production: classical economist identified three primary factors of production that is
land, labour and capital. They believed that the accumulation and efficient allocation of these
factors are essential for economic growth.

Law of diminishing returns: one of the essential central tenets of classical growth theory is the
law of diminishing returns which posits that as additional unit of variable inputs (eg labour or
capital) are added to fixed inputs eg land, the marginal products of variable inputs will eventually
deminishes.

Market mechanism: classical economists emphasized the role of free market and competitive
forces in allocating resources efficiently and promoting economic growth. They believed that
individual persuing their self interest withina market framework would lead to optimal outcomes
for a society as a whole.

Implications:

Capital accumulation. Classical economist argue that saving and investment are crucial for
capital accumulation which inturn drove economic growth. Policies that promoted thrift,
investment in physical capital such as machinery and infrastructure and technological process
were seen as key drivers of long term prosperity.

Specialisation and trade. Division of labour and specialisation as advocated by Adam Smith,
were believed due to enhanced productivity and output leading to economic growth.

Population growth. Classical economist held differing views on the implication of population
growth for economic growth. While Malthus warned on dangers of unchecked population growth
outstripping resources (Multhusian trap) others such as Ricardo believed that population growth
could be beneficial if accompanied by sufficient increases in production.

Criticisms:

11
Neglect of technological process. Classical economists tended to overlook the role of
technological innovation and progress in driving economic growth. They often assumed that
technological advancement were exogenous and denote explicitly incorperate them into the
growth models.

Limited scope of analysis. Classical growth theory focused primarily on physical capital
accumulation and labour productivity neglecting other important determinants of growth such as
human capital, technological change and institutional factors.

Static view of the economy. critics argue that classical theory are the static view of the economy
failing to account for dynamic processes such as creative destruction, entrepreneurship and the
structural change that are crucial for understanding modern growth dynamics.

Illustration: consider the industrial revolution in 18th and 19th century in Britain. Classical
economist would attribute the unprecedented economic growth during this period to factors such
as accumulation of physical such as factories and machinery, expansion of market through trade
and specialisation of labour in manufacturing industries. The rise of capitalism and adoption of
free market principles were seen as facilitating the efficient allocation of resources and driving
productivity gains leading to sustained economic growth over time.

Solo-Swan model: The Solo-Swan model also known as the neoclassical growth model was
developed by Robert Solow and Trevor Swan in the 1950s and 1960s . it focuses on the role of
physical capital accumulations and the technological progress in driving economic growth.

Features of Solo-Swan model:

Capital accumulation: The model emphasizes the role of of investment in physical capital such
asmachinery and equipments as a key driver of economic growth. According to the model,
increasing the capital stock leads to the higher outputs and income level.

Diminishing returns: The model assumes the diminishing marginal returns to capital, meaning
that as more capital is added, the additional increase in input diminishes over time.

Technological progress: The model incorperates technological progress as an exogenous factors

that improves productivity and economic growth. However it does not explain the resources and
mechanisms of technological progress.

12
Implications: The Solo-Swan model suggests that countries ith lower initial levels of capital
should experience faster economic growth as they have more rooms for capital accumulations.
However the model predicts that over time, the growth rates of countries will converge leading to
diminishing returns in per capita level of incomes.

Criticisms:

Technological progress: The Solo-Swan model assumes technological progress as an

exogenous variable ignoring thedeterminants and dynamics of innovation. It does not explain
why some countries experience faster technological progress than others.

Human capital and institutions: The model over looks the role of human capital i.e knowledge,
skills, education ans institutions such as property rights and political stability in driving
economic growth.

Convergence hypothesis: Empirical evidence does not always support the convergence
hypothesis as some countries have experienced persistent income gaps despite similar level of
capital accumulation.

Endogenous growth theories: Endogenous growth theory was developed in 1980s and 1990s by
the economists such as Paul Romer and Robert Lucas, expands on the Solo-Swan model by
emphasizing the role of human capital, knowledge and technological progress in driving long
term economic growth.

Features of Endogenous growth theories:

Human capital: Endogenous growth theory highlights the importance of human capital
accumulation through education, training, and reseach and development activities. A more
skilled and educated workforce is believed to enhance productivity and innovation.

Knowledge spillovers: The theory recognises the positive externalities associated with
knowledge and technology. It suggests that technology progress can spread from one firm or
individual to others leading to knowledge spillovers and increased productivity in the overall
economy.

13
Increasing returns to scale: Unlike the Solo-Swan model, endogenous growth theory assumes
increasing returns to scale meaning that an output can grow at an increasing rate without
diminishing returns.

Implications: Endogenous growth theory implies that policies that promotes investment in
education, research and development, innovation can lead to sustained economic growth. It
suggest that countries can persue strategies to actively faster technological progress and
knowledge accumulation.

Criticisms:

Measurement challenges: Endogenous growth theory faces challenges of in quantifying and

measuring the impact of human capital and knowledge on economic growth.

Assumptions and simplifications: Critics argue that the theory relies on unrealistic assumptions
such as perfect competition and constant return to scale, which limits its applicability.

Policy prescriptions: The theory provides broad policy implications but lack specific guidance
on the most effective policies to promote innovation and knowledge accumulations.

New growth theory: The new growth theory draws inspiration from the work of economist
Joseph Schumpeter who emphasized the role of entrepreneural activity in driving innovation and
economic growth. Entrepreneurs plays a critical roles in introducing new products, technologies
and business models disrupting existing markets and driving progress.

The theory recognises the importance of intellectual property rights in incentivizing innovation
and knowledge creation. By providing legal protections and exclusive rights to innovators and
inventors. The intellectual property rights encourage investment in research and development
and provide a framework for knowledge diffusion and commercialisation.

The new growth theory acknowledge that the economic growth involves the process of creative
destructions where outdated technologies and industries give ways to new ones. This process in
structural change can leads to a shift in employment, resources and productivity driving long
term economic growth.

14
Implications: The new growth theory suggest that policies promoting innovations,
entrepreneurship and the protection of intellectual property righs can have a significant impact
on long term economic growth. It highlights the importance of supportive institutional
framework in fostering innovation driven growth.

Criticisms:

Knowledge as a public goods. The theory overlooks the public good nature of knowledge since
the theory acknowledges the intellectual property rights which may not address the challenges of
knowledge diffusion.

Empirica challenges. Quantifying the impact of knowledge and innovation on economic growth
remains a challenge.

Structural change. Some critics argue that the new growth theory did not address some
challenges such as structural changes and the reallocation of resources accross sectors during he
process of innovation led growth.

Inconclusion, the new growth theory have expanded our understanding of the drivers of long
term economic growth beyond the traditional neoclassical framework. While the SOLO-SWAN
theory emphasises the physical capital and technological progress, endogenous growth theory
incorperates human capital and knowledge spillovers.

3b) Long run aggregate supply represents the total output an economy can pproduce when all
resources (labor, capital, technology etc) are fully utilised and there are no supply sided
constraints. It is the real level of GDP that an economy can sustain in the long run. Long run
aggregate supply is depicted as a vertical line on a graph, indicating that it is independent of
changes in the price level.

It is determined by the economy`s pottential output which is influenced by factors such as:

Quantity and quality of capital: The amount of physical capital (machinery, equipment)
available and its efficiency impacts an economy`s output pottential.

Quantity and quality of labour: The size of the labour force and the level of skills and
education of workers affects an economy`s productive capacity.

15
Technological progress: Improvements in technology and innovation can increase productivity
and expand the economy`s pottential output.

Natural resources: The availability and accessibility of natural resources also play a role in
determining an economy`s productive capacity.

Changes in long run aggregate supply can occur due to long term shifts in this factors. For
example investment in education and training can enhance labour productivity and shift LRAS to
the right, increasing the economy`s pottential outputs.

LRAS1 LRAS2

Inflation

Pe

SRAS AD1 AD2

Y1 Y2 YFC2

National income

An outward shift in LRAS helps to increase the economy`s underlying trend rate of growth
representing an increase in pottential GDP.

Trend rate of growth: Refers to the average rate at which country`s real GDP expands over an
extended period typically the long run. It represents the sustainable pace of growth that an
economy can maintain without causing significant inflation or deflation. The trend rate of growth
is influenced by various factors which includes the following:

Technological advancements: Improvement in technology can boost productivity and facilitate

economic growth.

Increase in capital stock: Expanding the economy`s stock of physical capital through
investments can contribute to higher output levels.

16
Growth in labour force: Expanding populationand labour force participation can support
economic growth.

Institutional factors: Factors such as political stability, the rule of law and well functioning
institutions can create a conducive environment for sustained economic growth.

A graph showing long run trend rate

Long run trend rate

GDP

Actual growth rate

Boom bust

TIME

The graph shows actual growth rate is fluctuating above and below the long run trend rate.

If growth is above the long-run trend rate we say their is positive output gap
(inflationary pressure boom).

If graph is below the long run trend rate, this creates a negative output gap (spare
capacity or bust)

In summary, the long run aggregate supply represents an economy`s pottential outputs when all
resources are fully utilused while the trend rate of growth signifies the sustainable pace of
economic expansion over an extended period.

4a) Foreign exchange refers to the relative values of different currencies in the global market.
While foreign exchange rate refers to the price of one currency interms of another currency.
They play a crucial role in the international trade and finance as they determine the cost of

17
exchange of exchanging currencies for another. The foreign exchange rate is determined by a
combination of market forces and government policies and it can fluctuate constantly in response
to vatious factors.

Market factors: The foreign exchange market operates as a decentralized global market, where
currencies are bought and sold. The interaction of supply and demand for currencies determines
the exchange rates. Some key factors influencing market forces includes:

Interest rates: Higher interest rates in a country attracts foreign investors, increasing
demand for the currency and strengthening it`s values.

Inflation rates: Countries with low inflation generally have stronger currencies because
their purchasing power is higher.

Economic performance: Strong economic growth and stability attract foreign investment
and increase the demand for a currency.

Political stability: Currencies of politically stable countries are more attractive to

investors, while can strengthen their values.

Balances of trade: Balance of trade which presents the differnce between a country`s
exports and imports can affect exchange rates. If a country has trade surplus (exports exceeds
imports) it increases the demand for its currencies leading to a stronger exchange rates.

Speculations: Speculators in the foreign exchange market can influence exchange rates
based on their expectations of future currency movements. Their actions can create short term
fluctuations in exchange rates

Illustrations of determinants of exchange rates in a free market

exchange rate(ugx/$) S

D2
D1
P2 e2
P e

18
 D1 D2
Demand for dollar/ unit time
The demand for forex is derived from demand for goods, services, specuations, securities and the
need to build foreign exchange reserves by the monetary authority.
Government policies: Government can influence foreign exchange through various policies as
seen below:
Central bank interventions. Central banks can buy or sells currencies in the foreign
exchange market to influence their value. For example a central bamk may intervene to stabilize
its currency during period of excessive volatility.
Monetary policy. Decisions regarding interest rates and money supply by central
banks affects the value of a currency. For example reducing interest rates can stimulate economic
growth and may also weaken the currency.
Capital control. Governnent can impose restrictions on capital flows to manage
exchange rates and protect their economies from external shocks.
Foreign Exchange rate regime is the way a country manages its currency in respect to foreign
currencies and the foreign exchange market. Different countries adopt different exchange rate
regimes to govern how their currencies are valued. Three main exchange rates regimes are as
seen below:
Floating exchange rate regime: Under a floating exchange rate regime, the value of a currency
is determined by market forces without significant government intervention. The exchange rates
fluctuates freely based on supply and demand. Many major currencies such as US dollars, Euros
and Japanese yen operate under floating exhange rate regime.
Fixed exchange rate regime: In a fixed exchange rate regime, the value of the currency is fixed
relative to another currency or a basket of currencies. Gonernment or central banks actively
intervene in the exchange market to maintain to maintain the exchange rate within a specific
range. This regime requires a significant reserves to support the fixed exchange rates. Examples
of fixed exchange rate regime includes the prgged system and the currency boards.
Managed floats/ dirty float regime: A managed float regime lies between a fixed and floating
exchange rate regime. The exchange rate is allowed to fluctuate within a certain range, but the
central banks periodically intervene to influence its value. The interventions can be aimed at
avoiding excessive volatility or achieving specific policy objectives.
Crawling peg: in a crawling peg system a country`s currency is pegged to another currecy but
with periodic adjustments to the fixed exchange rates. This adjustments are typically made in
response to changes in economic fundamentals or inflations rates.
It is important to note that countries can switch between exchange rate regime based on their
economic and policy objective. The choice of exchange rate regime depends on factors such as
economic stability, inflation rates, trade competitiveness and capital mobility.

19
4b) International monetary system refers to the framework and arrangement through which
international trade and financial transactions are conducted and currencies are exchanged. The
history of international monetary system is a complex and evolving story that spans for centuries
as discussed below:

Ancient and mediaval periods (Bimetallism (pre 1875): In ancient civilisation, barter and
commodity money systems were prevalent. Goods and services were exchanged directly without
the use of standardized currencies.
The use of precious metals such as gold and silver emerged as a common medium of exchange in
various regions.
During the middle age, currencies were often tied to specific quantities of gold or silver
standards. Some countries currencies in certain period were on either the gold standard (British
pound) or the silver standard ( German DM) and some on a bimetallic (French franc). Pound/
franc ex-rate was determined by the gold content of the two currencies. Franc/ DM was
determined by the silver content of the two currencies while pound/ DM was determined by their
exchange rates against the franc.
Gold standard era (1875- WWI): The international monetary system in this period was based
on the gold standard. Countries fixed their currencies to a specific amount of gold ensuring
convertibility and stability. The most notable example was the British pound sterling which
served as the global reserve currency. The system provided stability and facilitated international
trade and investment.
Gold standard exist when most countries used;
Gold coin as the primary medium of exchange.
Have a fixed ex-rate between ounce of gold and currencies.
Allows unrestricted gold flows (importation and exportation of gold).
Banknotes had to be backed with gold to assure full covertibility to god.
Domestic money and stock has to rise and fall with gold flows.
Interwar period and the great depression (1914-1944): The gold standard collapsed during the
world war 1, and attempt to restore it after the war were unsuccessful. The interwar period was
marked by economic instability and protectionist measures. The great depression of the 1930s
further strained the international monetary system, prompting countries to abandon the gold
standard and resort to exchange controls and competitive currency devaluations.
After the world war, hyperinflationary finance followed in many countries such as Germany,
Austria, Poland, Hungary. Price level incrreased in Germany by 1 trillion times. US (1919), UK
(1925), Switzerland returned to the gold standard during 1920s.
Bretton woods system (1945-1972): In 1945, the representative from 44 countries gathered at
the Bretton woods conference to design a new international monetary system. They established

20
the International Monetary Fund (IMF) and the world bank aiming to promote stability and
facilitate economic cooperation. Under the Bretton woods system, the US dollar was pegged to
gold and other currencies were pegged to dollars. This arrangement provided stability but put
significant pressure on the US due to the dollar`s role as the global reserve currency.
Evolution of exchange rate (1973- present): Since the collapse of Bretton woods system,
various exchange rate regimes have been adopted by countries. Some countries have chosen to
peg their currencies on other currencies or a basket of currencies, while others have allowed their
currencies to float freely. Regional monetary unions such as the European Monetary Union and
the adoption of Eoro have also emerged.
The International Monetary Fund continues to play a role in the promotion of stability and
providing policy advice to member countries.
Recent developments: In recent years, there have been discussions about the need of reforms in
the international monetary system. Issues such as currency manipilation, exchange rate volatility
and the role of emerging economies have been key points of debate.
The rise of cryptocurrency and the pottential impact on the international monetary system are
also areas of ongoing exploration and research.
Inconclusion, the international monetary system is a dynamic and evolving field, subject to
economic, political and technological developments. Various proposals and discussions
continues to shape it`s future trajectory.
4c) Balance of payment is a systemic records of all the economic transactions between a country
and the rest of the world over a specific period of time usually a year. It provide a comprehensive
summary of a country`s economic interactions with other countries including trade in goods and
services, financial transactions and transfers. It consists of two main accounts; the current accoun
and the capital and financialaccounts. The following are the steps of recording transactions in
balance of payment accounts:
Current accounts: Current accounts records transactions related to the trade in goods and
services, income flows and unilateral transfers.
Trade in goods: Goods exported and imported by a country are recorded in the
current account. When a country exports goods, it receives payments and when it imports goods,
it makes a payment. These transactions are reccorded under the merchandise trade balance.
Illustrations: lets say country A export $1 million worth of goods to country B. This transaction
would be recorded as a credit entry (+$1 million) in country A`s current account under the
merchandise trade balance representing an export of goods.
Trade in services: Services exported and imported by a country are also recorded in
the current accounts. Services includes sectors like tourism, transportation, financial services and
more.

21
Illustration: Suppose country country A provide $500,000 worth of IT consulting services to
country B. This transaction will be recorded under credit accounts representing an export of
services.
Income flows: Income flows includes earnings from foreign investments such as
divdidends, interests and profits.
Illustration: If an investor from country A earned $200,000 dividend from country B, the
ttransaction will be recorded as a credit in country A`s current account.
Unilateral transfers: Refers to one sided transfer of assets or funds between
countries without any direct economic exchange.
Illustration: Let`s say country A provides $100,000 in foreign aid to country B. This transaction
would be recorded as a debit entry (-$100,000) in country A`s current account under unilateral
transfers, representing an outflow of funds.
Capital and financial accounts: The capital and financial accounts records transactions that are
related to capital transfers, direct investments, portfolio investments and other financial flows.
The following transactions are recorded under capital and financial accounts.
Capital transfers: Capital transfers involves the transfer of ownership of fixed
assets such as land, buildings and patents between countries.
Illustration: If country A donates a piece of land worth $1000,000 to country B, this transaction
is recorded as a debit entry (-$1000,000) in country A capital and financial accounts under
capital transfers, representing an outflow of assets.
Direct investments: Direct investment involves the acquisition of controlling
stakes in foreign businesses or the establishment of new business abroad.
Illustration: Supposed country A based in country B invest $2000,000 to open a subsidiary in
country C, this transaction would be recorded as debit entry (-$2000,000) in country B`s capital
and financial accounts under direct investment representing an outflow of funds.
Portfolio investments: Portfolio investment refers to the purchase and sales of security such as
stock and bonds in foreign countries.
Illustration: If an investor from country A buys $500,000 worth of government bonds issued by
country B, this transaction would be recorded as a debit entry (-$500,000) in country A capital
and financial accounts under portfolio investment, representing an outflow of funds.
Inconcluclusion, these illustrations provide a simplified overview of how transactions are
recorded under the balanceof payment accounts. The actual process involves more categorisation
and subcategories to capture various types of transactions accurately.

22
REFERENCES:
W.W Rowstow, 1990, theories of economic growth from David Hume to the present day.
G. Reid 1989, classical economic growth.
Atkinson, Anthony B. (1969): The timescale of economic models: how long is the long run?,
review of economic studies, 36,137-152
Bairoch, paul (1975): the economic development of the third world since 1900, Berkerley:
university of carlifornia press.
Conway, E. (2015). The summit, Bretton woods, 1944: J.M Keynes and the reshaping of the
global economy. New york: Pegasus books.
Cooper. R (1987). The international monetary system: essays in world economics. Cambridge,
M.A: MIT Press.
Fischer,S. (2008). “mundell fleming lecture: exchange rate system, surveillance and advice”.
IMF staff papers, 55(3):367-83

23