File

1. IMS and Financial Markets
The Evolution of the IMS
(CGS) Classical gold standard: What it meant?
CGS existed from late 1800s to early 1900s was characterised by 3
conditions

2. Each member nation’s money supply consisted of gold or paper money backed
by gold.
Second, each member nation defined the official price of gold in terms of its
national currency and was prepared to buy orsell gold at that price.Third, the
free import and export of gold were permitted by members

3. In the light of above, a nation’s money supply was directly tied to its current
a/c. Surplus in current a/c would get gold and increase its money supply. And
conversely in case of deficit.
Modified gold standard required that the nation stock of money be fractionally
backed by gold at a constant ratio.

4. The essence of the classical price adjustment mechanism is embodied in
quantity theory of money. The equation of exchange
MV=PQ
This implies that total monetary expenditure on final goods equals the
monetary value of the final goods sold.

5. Difference between IMS and Global Financial
System
• IMS refers to institutional framework, rules and procedure by which
national currencies are exchanged for one another.
• Global-------the collective of financial institutions that facilitate and
regulate investment and capital flow world-wide such as central
banks, commercial banks and national stock exchanges.

6. Two Assumptions: Q was fixed at full employment level in the long term
Second they assumed that velocity of money was constant, depending
on institutional, structural and physical factors.
A change in M must induce a direct and proportionate change in P.

7. The linkages(current account-money supply-price level-current account)
showed Hume that over time current account equilibrium tends to be achieved
tends to be achieved automatically.
Criticisms: 1 notion of full employment challenged. 2.Changes in gold supply
and changes in money supply linkage does not hold. 3. Prices and wages are
inflexible in modern economy and thereby changes in M would affect income.

8. Post war years(1944-71)
Emergence of Bretton Woods System 1944 with 44 member countries.
1930s witnessed the collapse of international gold standard; economic and
financial crisis of 1929-33 dealt a severe blow to American and European
economies and these nations experimented with exchange controls and
competitive devaluation policies.

9. A semi-fixed exchange rate system known as adjustable pegged exchange rate
was adopted which lasted from 1946 to 1973.
Main features included:
Currencies were tied to each other to provide stable exchange rate for
commercial and financial transactions.

10. In case of fundamental disequilibrium in BOP, a nation was allowed to repeg its
currency up to 10% without permission from IMF.
Each member nation set the par value of its currency in terms of gold and US dollar.
Market exchange rates were being kept within a band of one percent on either side of
the parity; by 1971 exchange support margins were widened to 2.25%

11. Operational Problems
Under BW system, adjustment in prices and incomes often conflicted with
domestic stabilisation objectives.
Devaluation was considered undesirable as it showed a failure of domestic
policies and a loss of international prestige.
Revaluation hit the exports and were outcompeted in the international market.

12. • By late 1960s, the market price of gold reached around $ 40-42 per
ounce as against fixed rate of $35 per ounce fixed in 1944-45. Current
a/c surplus countries Germany and Japan started trading in gold
buying cheap and selling at higher market price and making good
profit.
• Adjustment under IMF System. IMF SAPs
• Two components: stabilisation policies and structural reforms

13. Stabilisation Policies imply to restore price and exchange rate stability y in the crisis
ridden economy.
Structural reforms refer to policy reforms in trade, finance, industry, agriculture,
labour and related sectors to push overall growth with focus on exports and
liberalisation of import regime.
In nutshell, it implies belt tightening program for the domestic consumers.

14. SAPs have been experimented in several countries during the last seven decades with
mixed results.
India’s experience of 1966 , 1980 and 19991.
Mexico(1994-95) East Asia (1997), Russia(1998), Brazil(1980s and 1999)
Argentina(2001) and PIIGS(2011-13)—a few noteworthy examples of SAPs.

16. Nature of Crisis
Currency crisis---a currency crisis is a situation in which a week currency
experiences heavy selling pressure. Among the several indications of selling
pressure-one is sizeable losses in the foreign reserves held by a country’s
central bank. Second is depreciating exchange rate in the forward market and
third, when inflation is running rampant.

17. Nature of Crisis
• Banking crisis results when domestic and foreign investors lose
confidence in a nation’s banking system, leading to massive
withdrawls of funds from banks and other financial institutions. USA
in 1930s, millions of people withdrew their funds, led to failure of
banks.
• Foreign debt crisis arises when a national govt. borrows an excessive
amt. of money from banks or by selling govt. bonds. In case of
Argentina, 2001 and Greece, 2011-12 foreign debt reached more than
150% of their GDP respectively.

18. Dollarisation
• Dollarisation occurs when residents of Argentina use dollar along side
PESO. Partial dollarisation when Argentine hold dollar denominated
bank deposits.
• Full dollarisation means the elimination of Argentine PESO and its
complete replacement with US dollar. Full dollarisation in Virgin and
Marshall islands, Puerto Rico, Guam and other Latin American
countries.
• WHY? Dollarisation imparts credibility and poicy discipline. Promise of
lower interest and inflation rates, financial stability and increased
economic activity. Decrease in transection cost, elimination of
currency risk, lower inflation thus enhanced economic growth