chapter 11 - international monetary system

Question 1

International monetary system

Answer 1

Refers to the institutional arrangements that govern exchange rates

Question 2

floating exchange rate regime

Answer 2

when the foreign exchange market determines the relative value of currency
Exchange rates are determined by market forces and fluctuate against each other

Question 3

pegged exchange rate

Answer 3

the value of the currency is fixed relative to a reference currency such as the US dollar (moves in accordance to the US dollar instead of the market)

Question 4

Managed/dirty float system

Answer 4

The value of the currency is determined by market forces, but managed by the government (demand and supply)

Question 5

fixed exchange rate

Answer 5

The values of a set of currencies are fixed against each other at some mutually agreed-on exchange rate
i.e. the EU monetary system (regardless of which countries are in the EU)

Question 6

Gold standard

Answer 6

Pegging currencies to gold and guaranteeing convertibility

Question 7

Mechanics of the gold standard

Answer 7

1880: the value of any currency in units of any other currency (the exchange rate) was easy to determine
Gold par value: The amount of currency needed to purchase one ounce of gold

Question 8

Strengths of gold standard

Answer 8

balance of trade equilibrium:
the income its residents earn from exports is equal to the money its residents pay to other countries for imports
abandoned in 1914, then tried again until 1939 truly dead

Question 9

The Bretton-Woods system

Answer 9

around WWII, 44 countries met to decide on new international monetary system. two institutions were born;

• IMF
• World bank

Question 10

World bank

Answer 10

-initial mission was to help finance the building of Europe’s economy by providing low-interest loans
The bank returned its focus to development and began lending money to third world countries

Question 11

IMF

Answer 11

tasked with maintaining order in the international monetary system through discipline
rights to lend but also to impose conditions + adjustable parities

Question 12

world bank has two lending schemes

Answer 12

1. IBRD

2. IDA (International development Association)

Question 13

IBRD

Answer 13

Lends money by raising money through bond sales in the international capital market

• Borrowers pay a market rate of interest- the bank’s cost of funds plus a margin for expenses
• The bank offers low interest loans to risky customers whose credit rating is often poor, such as the governments of underdeveloped nations

Question 14

IDA

Answer 14

Resources to fund IDA loans are raised through subscriptions of wealthy members such as the U.S, Japan and Germany.
IDA loans go to the poorest countries
Borrowers have 50 years to repay at an interest rate of less than 1% a year

Question 15

collapse of bretton woods system in 1973

Answer 15

• ->Managed-float system now in place
• ->Traced break-up of fixed exchange rate system to US macroeconomic policy package of 1965-1968
• ->dollar devalued

Question 16

Floating exchange rate regime

Answer 16

The jamaica agreement: floating exchange rates were acceptable, gold was a reserve asset and total annual IMF quota were increased

Question 17

Exchange rates since 1973

Answer 17

• > more volatile
• > less predictable
• > fluctuations in dollar value

Question 18

favourable factors to overcome unfavourable effect of trade deficit

Answer 18

Strong economic growth in US: heavy inflow of capital and high real interest rates
political turmoil in rest of the world:

Question 19

the case for floating exchange rate

Answer 19

Monetary political autonomy
automatic trade balance adjustment
Economic recovery following severe economic crisis

Question 20

Monetary political autonomy

Answer 20

expand or contract money supply
inflation puts pressure on a fixed system
contraction puts upward pressure on fixed system
The removal of the obligation to maintain exchange rate parity would restore monetary control to a government.

Question 21

Automatic trade balance adjustment

Answer 21

works more smoothly under floating exchange rate, does not require the IMF to agree to currency devaluation if there is a deficit

Question 22

Economic recovery

Answer 22

exchange rate adjustments can help a country deal with economic crisis because Reason for this is that investors respond to the crisis by taking their money out of the country, selling the local currency, and driving down its value, then it becomes so cheap it stimulates exports

Question 23

The case for fixed exchange rates

Answer 23

1. monetary discipline
2. speculation
3. uncertainty
4. trade balance adjustments and economic recovery

Question 24

Monetary discipline

Answer 24

ensures that governments do not expand their money supplies at inflationary rates
governments should not be able to influence inflation because they often take it too far

Question 25

Speculation

Answer 25

with floating exchange rates, speculation can cause fluctuations in the currency value
–>damage a country’s economy by distorting export and import prices

Question 26

Uncertainty

Answer 26

floating exchange rate has uncertainty surrounding future currency movements which adds risk to exporting, importing, and foreign investment activities (Not present with fixed) therefore it promotes the growth of international trade and investment

Question 27

pegged exchange rates in practice

Answer 27

1. Country will peg value of its currency to that of a major currency
2. Popular among smaller nations
3. Imposes monetary disciplines on country and leads to low inflation

Question 28

Currency boards (governing bodies)

Answer 28

1. converting its domestic currency on demand into another currency at fixed exchange rate
2. Holds reserve of foreign currency equal at fixed exchange rate to at least 100 percent of domestic currency issued
3. Can issue additional domestic notes and coins only when there are foreign exchange reserves to back it

Question 29

Financial crisis post Bretton Woods

Answer 29

Currency crisis
banking crisis
foreign debts crisis

Question 30

Currency crisis

Answer 30

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 to defend the previous exchange rate

Question 31

banking crisis

Answer 31

Refers to a loss of confidence in the banking system that leads to a run on banks, as individuals and companies withdraw their deposits

Question 32

foreign debt crisis

Answer 32

a country cannot service its foreign debt obligations, whether private-sector or government debt

Question 33

Causes of these crises

Answer 33

High relative price inflation rates
Widening current account deficit
Excessive expansion of domestic borrowing 
High government deficits
Asset price inflation

Question 34

IMF’s policy prescription

Answer 34

counterproductive or only had limited success

Also notable accomplishments

Question 35

Currency management

Answer 35

Combination of government intervention and speculative activity can drive the foreign exchange market
Must adjust accordingly

Question 36

Business strategy

Answer 36

increase strategic flexibility in the face of unpredictable exchange rate movements

Question 37

Corporate-government relations

Answer 37

Business can influence government policy toward the international monetary system (lobbyist)
try to minimizes volatile exchange rate movements, particularly when those movements are unrelated to long run economic fundamentals