The International Monetary System

LO 2
LO 1
Explain the role played by the
Describe the historical
World Bank and the IMF in
development of the modern
the international monetary
global monetary system.
system.

LO 4
LO 3

Learning Compare and contrast the

differences between a fixed
Identify exchange rate
regimes used in the world
today and why countries

Objectives
and a floating exchange rate
adopt different exchange rate
system.
regimes.

LO 5
LO 6
Understand the debate
Explain the implications of
surrounding the role of the
the global monetary system
IMF in the management of
for management practice.
financial crises.
 Introduction

The international monetary system is the institutional arrangement that govern exchange
rates
• Recall that the foreign exchange market is the primary institution for determining exchange rates

A floating exchange rate system exists where the foreign exchange market determines the
relative value of a currency

A pegged exchange rate system exists when the value of a currency is fixed to a reference
country and then the exchange rate between that currency and other currencies is
determined by the reference currency exchange rate
 A managed float or dirty float exists when the
value of a currency is determined by market
forces, but with central bank intervention if it
depreciates too rapidly against an important
reference currency

Introduction With a fixed exchange rate system countries fix

their currencies against each other at a mutually
agreed upon value

• Prior to the introduction of the euro, some European Union

countries operated with fixed exchange rates within the context
of the European Monetary System (EMS)
 The origin of the gold standard dates back to
ancient times when gold coins were a
medium of exchange, unit of account, and
store of value

The Gold
Standard To facilitate trade, a system was developed so
that payment could be made in paper
currency that could then be converted to gold
at a fixed rate of exchange
 Mechanics of the Gold Standard

The exchange rate between

The gold standard is the Under the gold standard one
currencies was based on the
practice of pegging currencies to U.S. dollar was defined as
gold par value: the amount of a
gold and guaranteeing equivalent to 23.22 grains of
currency needed to purchase one
convertibility "fine” (pure) gold
ounce of gold
 The key strength of the gold standard
was its powerful mechanism for
simultaneously allowing all countries
to achieve balance-of-trade
equilibrium
Strength of the
Gold Standard When the income a country’s
residents earn from its exports is equal
to the money its residents pay for
imports
 The Period Between the Wars: 1918-1939

The gold standard worked fairly well from the 1870s until the start of World War I

After the war countries started regularly devaluing their currencies to try to encourage
exports

Confidence in the system fell, and people began to demand gold for their currency
putting pressure on countries' gold reserves, and forcing them to suspend gold
convertibility

The Gold Standard ended in 1939

 A new international monetary system was designed in
1944 in Bretton Woods, New Hampshire
• The goal was to build an enduring economic order that would facilitate
postwar economic growth

The Bretton Woods Agreement established two

The Bretton multinational institutions

Woods System The International Monetary Fund (IMF) to maintain

order in the international monetary system

The World Bank to promote general economic

development
 The U.S. dollar was the only currency to be
convertible to gold, and other currencies would
set their exchange rates relative to the dollar

Under the
Bretton Woods Devaluations were not to be used for
competitive purposes
Agreement

A country could not devalue its currency by

more than 10% without IMF approval
 Discipline

• A fixed exchange rate puts a brake on

competitive devaluations and brings stability to
the world trade environment
• A fixed exchange rate regime imposes monetary
discipline on countries, thereby curtailing price
The Role of the inflation

IMF Flexibility

• IMF ready to lend foreign currencies to members

to tide them over during short periods of balance-
of-payments deficits
• A country could devalue its currency by more
than 10% with IMF approval
 The Role of the World Bank

Under the IBRD scheme, money is

raised through bond sales in the
Under the International
international capital market and
Development Agency scheme,
borrowers pay what the bank calls
loans go only to the poorest
a market rate of interest - the
countries
bank's cost of funds plus a margin
for expenses.
 The World Bank was created in 1944 as an international financial

Does the World institution of the United Nations that would provide loans to
developing countries for capital investments in the country. Broadly,
the World Bank’s official goal is the reduction of poverty in the
Bank Make global marketplace. According to its Articles of Agreement, all of the
World Bank’s decisions must be guided by a commitment to the

Global Markets promotion of foreign investment and international trade and to the
facilitation of capital investment. These goals are admirable to most

Less people and countries, but what effect does lending to developing
countries have on the rest of the world? Would it be better or worse

Competitive?
if lending was only based on risk assessments and financial
opportunities of countries in a free market system?
 The collapse of the Bretton Woods system can be
traced to U.S. macroeconomic policy decisions
(1965 to 1968)

During this time, the U.S. financed huge increases

Collapse of the in welfare programs and the Vietnam War by
Fixed Exchange increasing its money supply which then caused
significant inflation
Rate System
Speculation that the dollar would have to be
devalued relative to most other currencies forced
other countries to increase the value of their
currencies relative to the dollar
The Bretton Woods system
relied on an economically
well managed U.S.
• When the U.S. began to print
The Bretton Woods
money, run high trade deficits, and Agreement collapsed in
experience high inflation, the 1973
system was strained to the breaking
point

Collapse of the Fixed Exchange Rate System

 The Floating Exchange Rate Regime

Following the collapse of

The rules for the
the Bretton Woods
international monetary
agreement, a floating
system that were agreed
exchange rate regime was
upon at the meeting are
formalized in 1976 in
still in place today
Jamaica
 The Floating Exchange Rate Regime

At the Jamaica meeting, the IMF's Articles

of Agreement were revised to reflect the
new reality of floating exchange rates.
Floating rates were declared acceptable.
The Jamaica Agreement Gold was abandoned as a reserve asset.
Total annual IMF quotas - the amount
member countries contribute to the IMF -
were increased to $41 billion (today, this
number is $767 billion)
 Exchange Rates Since 1973
 Have become more volatile and less predictable
 The oil crisis in 1971
 The loss of confidence in the dollar after U.S. inflation

The Floating
jumped between 1977 and 1978
 The oil crisis of 1979
 The unexpected rise in the dollar between 1980 and 1985
Exchange Rate  Rapid fall of dollar against Japanese yen and German
deutsche mark

Regime  The partial collapse of the European monetary system in

1992
 The 1997 Asian currency crisis
 The global financial crisis of 2008-2010 and the EU
sovereign debt crisis during 2010-2011
 The Case for Floating Exchange Rates
 Monetary Policy Autonomy

Fixed Versus  The removal of the obligation to maintain

exchange rate parity restores monetary

Floating control to a government

 With a fixed system, a country's ability to
Exchange Rates expand or contract its money supply is
limited by the need to maintain exchange
rate parity
 The Case for Floating Exchange Rates continued
 Trade Balance Adjustments
 The balance of payments adjustment mechanism
works more smoothly under a floating exchange rate

Fixed Versus 
regime
Under the Bretton Woods system (fixed system), IMF

Floating approval was needed to correct a permanent deficit in

a country’s balance of trade that could not be corrected

Exchange Rates by domestic policy alone

 Crisis Recovery
 Supporters of floating rates argue that they
automatically help countries deal with economic
crises
 The Case for Fixed Exchange Rates
 Monetary Discipline
Fixed Versus  Because a fixed exchange rate system
requires maintaining exchange rate parity, it
Floating also ensures that governments do not expand

Exchange Rates their money supplies at inflationary rates

 Speculation
 A fixed exchange rate regime prevents
destabilizing speculation
 The Case for Fixed Exchange Rates continued
 Uncertainty

Fixed Versus  Uncertainty associated with floating exchange

rates makes business transactions more risky

Floating  Trade Balance Adjustments and Economic

Exchange Rates Recovery

 Floating rates help adjust trade imbalances and
can help with economic recovery after a crisis
 Who is Right?
 There is no real agreement as to which
system is better

Fixed Versus  History shows that a fixed exchange rate

regime modeled along the lines of the
Floating Bretton Woods system will not work

Exchange Rates  A different kind of fixed exchange rate

system might be more enduring and might
foster the kind of stability that would
facilitate more rapid growth in
international trade and investment
 The case for a floating exchange rate includes monetary
policy autonomy, trade balance adjustments, and crisis
recovery issues. The case for a fixed exchange rate

Floating or includes monetary discipline, speculation issues,

uncertainty, trade balance adjustments and economic
Fixed Exchange recovery. We conclude these topics with a short section
on “who is right” without actually addressing this very
Rates? complex issue. But, what do you think? Who is right?
Should we have a floating or fixed exchange rate
system?
 Currently, there are several different exchange rate
regimes in practice

Exchange Rate  21% of IMF members allow their currencies to float

freely
Regimes in  23% of IMF members follow a managed float system
 5% of IMF members have no legal tender of their own
Practice (excluding EU countries that use the euro)
 The remaining countries use less flexible systems such
as pegged arrangements, or adjustable pegs
 Pegged Exchange Rates
 Under a pegged exchange rate regime

Exchange Rate countries peg the value of their currency to

that of other major currencies
Regimes in  Popular among the world’s smaller nations
 There is some evidence that adopting a
Practice pegged exchange rate regime moderates
inflationary pressures in a country
 Currency Boards
 A country with a currency board commits to
converting its domestic currency on demand into

Exchange Rate another currency at a fixed exchange rate

 The currency board holds reserves of foreign
Regimes in currency equal at the fixed exchange rate to at
least 100% of the domestic currency issued
Practice  Additional domestic notes and coins can be
introduced only if there are foreign exchange
reserves to back it
The IMF has redefined its mission, and
now focuses on lending money to
countries experiencing financial crises in
exchange for enacting certain Crisis
macroeconomic policies
 Membership in the IMF has grown
Management
to 188 countries in 2014, of which by the IMF
33 has some type of IMF program in
place
Financial Crises in the Post-Bretton Woods Era
1. Currency crisis occurs when a speculative
attack on the exchange value of a currency
results in a sharp depreciation in the value of
the currency, or forces authorities to expend
large volumes of international currency
reserves and sharply increase interest rates in
Crisis
order to defend prevailing exchange rates Management
2. Banking crisis refers to a loss of confidence in
the banking system that leads to a run on the by the IMF
banks
3. Foreign debt crisis is when a country cannot
service its foreign debt obligations, whether
private sector or government debt
The International Monetary Fund (IMF) is an organization of 188
countries working to foster global monetary cooperation, secure

Is the
financial stability, facilitate international trade, promote high
employment and sustainable economic growth, and reduce poverty
around the world. It is a specialized agency of the United Nations
but has its own charter, governing structure, and finances. Its
members are represented through a quota system broadly based on International
Monetary
their relative size in the global economy. The Board of Governors,
the highest decision-making body of the IMF, consists of one
governor and one alternate governor for each member country. The
governor is appointed by the member country and is usually the
minister of finance or the governor of the central bank. Fund
Should the IMF’s one-size fits-all approach (see the section on "
Inappropriate Policies" in this chapter) be evaluated? If yes,
how would you change it? If no, why not?
Needed?
Source: http://www.imf.org
Evaluating the IMF’s Policy Prescriptions
 In 2016, 30 countries were working IMF
programs
 All IMF loan packages come with
conditions attached, generally a
combination of tight macroeconomic policy
Crisis
and tight monetary policy Management
 Many experts have criticized these policy by the IMF
prescriptions
 Inappropriate policies
 Moral hazard
 Lack of accountability
Evaluating the IMF’s Policy Prescriptions continued
 Inappropriate Policies
 The IMF has been criticized for having a
“one-size-fits-all” approach to
macroeconomic policy that is


inappropriate for many countries
Moral Hazard Crisis
 The IMF has also been criticized for
exacerbating moral hazard: people
Management
behave recklessly because they know they
will be saved if things go wrong
by the IMF
 Lack of Accountability
 The IMF has become too powerful for an
institution that lacks any real mechanism
for accountability
 Focus on Managerial Implications

Currency Management, Business Strategy, and Government Relations

The international monetary system Currency management

affects international managers in Business strategy
three ways Corporate-government relations
Currency Management
 The current exchange rate system is
a managed float
 Government intervention and Focus on
speculative activity
currency values
influence
Managerial
 Firms can protect themselves from Implications
exchange rate volatility through
forward markets and swaps
Business Strategy
 The forward market can offer some
protection from volatile exchange rates in
the shorter term
 Firms can protect themselves from
exchange rate uncertainty over the longer
Focus on
term by building strategic flexibility into
their operations that minimizes economic
Managerial
exposure Implications
 Firms can disperse production to
different locations
 Firms can outsource manufacturing
Corporate-Government Relations
 Firms can influence government
policy towards the international
monetary system
 Firms should focus their efforts on Focus on
encouraging the government Managerial
 Promote the growth of
international trade and investment
Implications
 Adopt an international monetary
system that minimizes volatile
exchange rates
 Summary

Explained the role played Compared and contrasted

Described the historical
by the World Bank and the the differences between a
development of the modern
IMF in the international fixed and a floating
global monetary system.
monetary system. exchange rate system.

Identified exchange rate Explained the implications

Understood the debate
regimes used in the world of the global monetary
surrounding the role of the
today and why countries system for currency
IMF in the management of
adopt different exchange management and business
financial crises.
rate regimes. strategy