The International Monetary System Flashcards
What are floating or flexible rates?
They fluctuate according to market forces. They depreciate (decrease in value of one currency against another) and appreciate (rise in the value of one currency against another)
What are fixed exchange rates?
They do not fluctuate and are constant over time. They can have a devaluation (official reduction in the par value of a currency by the government of that currency) and a revaluation (official increase in the par value of a currency by the government of that currency)
What is the gold standard?
- from 1876-1913
- Gold has been medium of exchange since 300BC
- each country would set a rate at which its currency could be converted to a weight of gold
- exchange rates were fixed
- Expansionary monetary policy was limited to government supply of gold
- In effect until WW1
What is Bretton Woods and the International Monetary Fund?
-1945 to 1973
- Established in 1944 as a fixed exchange rate system by the international monetary fund (IMF)
- Dollar pegged to gold and all other currencies were set at fixed rates against the dollar
- Dollar only currency convertible to gold and main international reserve currency
- Foreign banks buy/sell dollars to keep parity. This caused involuntary decrease and increase in foreign money supplies
- US has monetary independence
- BOP imbalances to be offset by a buffer stock of international reserves and IMF credits
What is IMF
key institution in the new international monetary system. Created to:
- Help countries defend their currencies against cyclical, seasonal or random occurences
- Assist countries having structural trade problems if they promise to take adequate steps to correct these
- Special drawing rights is the IMF reserve assets. Weighted average of five currencies including the Chinese Renminbi
What caused the demise of fixed exchange rates?
- US dollar became main reserve currency which resulted in a consistent and growing BOP deficit which required heavy capital outflow of dollars.
- Heavy overhang of dollars held by foreigners resulted in a lack of confidence in the US to meet its commitment to convert dollars to gold
- Lack of confidence forced President Nixon to suspend purchase/sale of gold by US treasury on august 15, 1971.
- Caused devaluation of the dollar and currencies were allowed to float to levels determined by market forces
What is the floating era?
- 1973-1997
- Exchange rates are much more volatile and less predictable than they were during the fixed period
What is the emergin era?
- Emerging market economics and their currencies are multiplying in number and growing in complexity
What are the four categories of IMF classification of currency regimes?
Category 1: Hard Pegs (13.0%)
– Countries that have given up their own sovereignty over monetary policy
– E.g., dollarization or currency boards
*Category 2: Soft Pegs (39.6%)
– AKA fixed exchange rates, with five subcategories of classification
*Category 3: Floating Arrangements (37%)
– Mostly market-driven, these may be free floating or floating with occasional government intervention
Category 4: Residual (10.4%)
– The remains of currency arrangements that don’t well fit the previous categorizations
What are fixed exchange rates?
It is pegged to something
Hard peg: Extreme currency regime peg forms such as currency boards and dollarization
Soft Peg: Fixed exchange rates where authorities maintain a set band about some other currency
What are floating exchange rates?
They are market driven.
Managed float: market forces of supply/demand set exchange rate with occasional government intervention
free Float: market forces of supply/demand set exchange rate with NO government intervention
How is the choice between fixed vs flexible exchange rates determined?
Decision reflects national priorities about all facets of the economy such as inflation, unemployment, interest rates, trade balances, economic growth.
Choice between fixed/flexible could change over time
Why would a country prefer a fixed rate regime and what could be the problems with a fixed rate regime?
Prefer: stable international prices and anti-inflationary nature
Problems: Need for central bank to maintain large quantity of hard currencies and gold to defend rate and the maintained rates can be inconsistent with economic fundamentals.
Why would a country prefer a floating rate regime and what could be the problems with a floating rate regime?
Prefer: Monetary policy autonomy, easier excahnge rate adjustments, avoid currency crises.
Problem: Detrimental for global trade!
Review global outloon of IMF
OKAY its on slides 20/21