SlideShare a Scribd company logo
1 of 201
Unit 4. International Monetary System
4. International Monetary System:
The International Financial System
- Reform of International Monetary Affairs
- The Bretton Wood System and the International
Monetary Fund, Controversy over Regulation of
International Finance, Developing Countries'
Concerns, Exchange Rate Policy of Developing
Economies.
International Financial System
The international financial system (IFS)
constitutes the full range of interest‐ and
return‐bearing assets, bank and nonbank
financial institutions, financial markets that
trade and determine the prices of these
assets, and the nonmarket activities (e.g.,
private equity transactions, private
equity/hedge fund joint ventures, leverage
buyouts whether bank financed or not, etc.)
through which the exchange of financial assets
can take place.
The IFS lies at the heart of the global credit
creation and allocation process.
To be sure, the IFS depends on the effective
functioning and prudent management of the
IMS and the ready availability of currencies to
support the payment system.
Nevertheless, the IFS extends far beyond IMS’s
common payments and currency pricing role
to encompass the full range of financial
assets, including derivatives, credit classes
and the institutions that engage in the
exchange of these assets as well as their
regulatory and governing bodies.
The IFS encompasses the IMS — but extends
in function and complexity well beyond the
IMS.
Government debt links the two systems, as
government debt can function as “near
money” in a zero interest rate environment.
Many financial transactions pass through a
stage of payment in money (i.e., a demand
deposit) — quickly —to a “riskless”
interest‐bearing asset, like government
bonds.
When “riskless” assets become more “risky”
and less liquid, the payment system slows
down and may even be upended.
Three features of the international financial
system in the 21 st century:
―the currency system,
―capital flows,
―the responsibilities of authorities in
the major economies.
(1) The international monetary system (how
exchange rates, balance of payments and
macroeconomic management are
managed and adjusted globally) is part of
a broader international regime. As such, it
is influenced strongly by the way power is
distributed and exercised in the world, as
well as the presence or absence of a
powerful and reliable leader country.
(2) Over time, international monetary
systems exhibit oscillation between two
opposites: for example, (i) general floating
versus general fixity, (ii) stability versus
instability, and (iii) free capital mobility
versus no such mobility. It is hard to say
which situation is normal and which is
abnormal. People often believe that the
prevailing system is normal and
permanent, but it usually isn't. Whether
capital mobility has become irreversible in
the 21st century is an interesting and
open question.
(3) "The triangle of impossibility": Consider (i)
exchange rate stability (i.e., fixed exchange
rates), (ii) monetary policy independence,
and (iii) free capital mobility. These three
things are regarded as desirable, but only
two can be realized at any time. Different
international monetary systems emerge
depending on which one we give up. For
example, if we abandon the first, we have a
floating rate system; and if the second is
removed, monetary union like EU will
emerge, and so on.
(4) Since the 19th century, there has been a
gradual movement away from commodity
money (typically gold) toward paper money
(managed currency).
The problem with gold is its quantity is too
constraining, which is also a merit if the
central bank is irresponsible. In the 21st
century, maybe we will have e-money which
has completely new characteristics (and
risks).
The Currency System
The safest judgment is that the currency
system will continue to evolve along with
the evolution of the international financial
system.
Article IV of the IMF Articles of Agreement
calls upon members to assure orderly
exchange rate arrangements and to
promote a stable system of exchange rates
not a stable exchange rate system.
The Currency System
In a rapidly changing international financial system,
the search for comprehensive approaches to
global exchange rate systems is likely to be
unrewarding.
When it comes to exchange rate regimes, there are
no panaceas.
It is easy to demonstrate that there is no single
regime that is best for any national economy
under all economic and financial circumstances;
the disturbances with which regimes must cope
change over time.
The Currency System
National authorities have to make choices about
which regime on balance will best serve their
economies; because changes in regimes are not
costless. Eclecticism also is not a realistic option.
Similarly no global currency system promises to
serve best the interests of the global financial
system under all conditions.
The economic case for a trade bloc rests on
the observation that ex ante trade barriers
are high; the establishment of the trade
bloc serves on balance to reduce trade
distortions, creating more trade than is
diverted.
Currency blocs, on the other hand, run the
risk of increasing distortions through the
erection of barriers to the free flows of
finance where few exist today, at least
among the major currencies and financial
markets.
Capital Flows
Consider a regime with a common global
currency.
Under such a regime, as with national
monetary systems, capital flows would not
be immune from irrational exuberance or
despondence, and crises would continue
to be possible.
At a pragmatic level, responding to potential
problems associated with international
capital flows by the imposition of controls
on those flows is likely over time to prove
to be inefficient (and, therefore, costly),
ineffective, or both, unless the national
financial market itself is tightly controlled or
highly underdeveloped.
Moreover, as countries develop and grow,
controls are relaxed and financial systems
are opened up.
Better response to the potential problems
associated with international capital flows
lies in the promotion of sound
macroeconomic policies, flexible markets,
robust financial systems supported by
appropriate regulations and supervision,
transparency about regimes and
institutions, and adherence to agreed
global standards.
Responsibilities of Authorities in the Major
Economies
In order to provide support for the appropriate evolution
of the international financial system in the 21 st
century, the authorities in the major economies should
implement sound macroeconomic and structural
policies, demonstrate their respect for market forces,
and endeavor to follow a policy of inclusion when it
comes to establishing the rules and principles that will
guide and govern the financial system. All this may
sound like very little, but it is remarkable how taxing it
is to accomplish these tasks effectively and
successfully.
The United Nations Monetary and Financial
Conference, commonly known as Bretton Woods
conference, was held in Bretton Woods, New
Hampshire, USA to regulate the international
monetary and financial order after the conclusion
of World War II.
The aim was to help rebuild the shattered
post-war economy ( WW2 had just finished
in 1945) and to promote international
economic cooperation.
The conference resulted in the agreements
to set up the International Bank for
Reconstruction and Development
(IBRD)- popularly known as World Bank
and the International Monetary Fund
(IMF).
The IMF was set up to foster monetary
stability at global level. The IBRD was
created to speed up post-war
reconstruction. The two institutions are
known as the Bretton Woods twins.
Origins of Bretton Woods
Political origin lies in 2 key conditions –
Shared experiences of 2 World Wars, with the
sense that failure to deal with economic
problems after the first war had led to the
second <Treaty of Versailles demanding
massive reparation amount from
Germany being the cause of collapse of
German economy and Hitler’s rise to power>
The concentration of power in a small number
of states (US and Western Europe)
Members of Bretton Woods Family aka Bretton Woods
Twins
1. International Monetary Fund(IMF) – To maintain
global financial stability through technical assistance,
training, and loans to member states to tide over short
term balance of payment crisis
2. World Bank (WB) Group – Consisting of 5 agencies
which provides vital financial and technical assistance to
developing countries around the world to reduce global
poverty
Remember that WTO has nothing to so with Bretton Woods.
It officially commenced only in 1995 under the Marrakesh
agreement and replace General Agreement on Tariff and
trade (GATT)
The Bretton Woods System is a set of unified rules and
policies that provided the framework necessary to
create fixed international currency exchange rates.
Essentially, the agreement called for the newly
created IMF to determine the fixed rate of exchange
for currencies around the world. Every represented
country assumed the responsibility of upholding the
exchange rate, with incredibly narrow margins above
and below. Countries struggling to stay within the
window of the fixed exchange rate could petition the
IMF for a rate adjustment, which all allied countries
would then be responsible for following.
The system was depended on and was used heavily
until the beginning of the 1970s.
The Collapse of the Bretton Woods System
Backing currency by the gold standard started to become a
serious problem throughout the late 1960s. By 1971, the
issue was so bad that US President Richard Nixon gave
notification that the ability to convert the dollar to gold was
being suspended “temporarily.” The move was inevitably
the final straw for the system and the agreement that
outlined it.
Still, there were several attempts by representatives,
financial leaders, and governmental bodies to revive the
system and keep the currency exchange rate fixed.
However, by 1973, nearly all major currencies had begun
to float relatively toward one another, and the entire
system eventually collapsed.
A brief World War II Timeline
Adolf Hitler demanded that Gdansk be given to
Germany, claiming that Gdansk residents were
predominantly German. Backed by France and
Britain, Poland refused. With this excuse, Germany
invaded Poland on September 1, 1939.
Recall that the representatives of the US and its
Allies worked out three post-war arrangements
(i) ITO (still-born), replaced by GATT and WTO.
(ii) IBRD (which became the World Bank), and
(iii) IMF, immediately after the Normandy invasion
in June 1944.
Stable and adjustable exchange rates
For 25 years after WWII, the international monetary
system known as the Bretton Woods system, was
based on stable and adjustable exchange rates.
Exchange rates were not permanently fixed, but
occasional devaluations of individual currencies
were allowed to correct fundamental disequilibria
in the balance of payments (BP). Ever-increasing
attack on the dollar in the 1960s culminated in the
collapse of the Bretton Woods system in 1971,
and it was reluctantly replaced with a regime of
floating exchange rates.
loss of national sovereignty
• By signing the agreement, nations were
submitting their exchange rates to
international disciplines.
• This amounted to a significant surrender of
national sovereignty to an international
organization.
• Territorial waters = 12 nautical miles. US
navy ships patrolled near Spratly
archipelago on international waters (outside
12 nm).
Advantages over the gold exchange standard
Deflationary policy: Under the gold exchange
standard, a country has to resort to the classical
medicine of deflating the domestic economy when
faced with chronic BP deficits.
Before World War II, European nations often used
this policy, in particular the Great Britain. Even
though few currencies were convertible into gold,
policy makers thought that currencies should be
backed by gold and willingly adopted deflationary
policies after WWI.
Advantages over the gold exchange standard
Deflationary policy is not the only option when faced
with BP deficits. Devaluation is accepted in
Bretton Woods.
The adjustable peg was viewed as a vast
improvement over the gold exchange standard
with fixed parity.
Currencies were convertible into gold, but unlike the gold
exchange standard, countries had the ability to change par
values of their currencies . For this reason, Keynes
described the Bretton Woods system as "the exact
opposite of the gold standard." The world economy tripled
in size during the two decades, but gold supply did not
change much.
Unanticipated Problems
Structural problems: (i) Over time the world
economy grew and needed more liquidity or
reserve assets. ⇒ Marshall Plan Aid.
Gate of Honor, Versaille Palace
"Wir wollen Kohle, Wir wollen Brot" (We want
coal, We want bread). (former) President Herbert
Hoover (1947): The whole economy of Europe is
interlinked with German economy through the
exchange of raw materials and manufactured
goods.)
(ii)
Unanticipated Problems
(ii) Given the fixed quantity of gold (192,000 tons or
6.2 billion ounces, annual production of gold = 80
million ounces = $100 billion), other countries had
to hold US dollar and gold as reserve. Keynes
had proposed that a world reserve currency be
created and managed by a central bank. (Today
IMF manages SDR.)
(iii) As the world economy grew, the increased world
demand for dollar as reserve assets meant that
US had to incur increasing trade deficits.
Unanticipated Problems
The dollar was the numéraire of the system, i.e., it was
the standard to which every other currency was
pegged. Accordingly, the U.S. did not have the power
to set the exchange rate between the dollar and any
other currency.
Changing the value of dollar in terms of gold has no real
effect, because the parities of other currencies were
pegged to the dollar. This is the n-th currency
problem. This problem would not have existed if most
of other currencies were pegged to gold. However,
none of these currencies were pegged to gold
because they were not convertible into gold. (limited
supply of gold)
Invasion of Normandy (June 6, 1944)
International Monetary Fund and World Bank
meeting was held in July 1944 in Bretton Woods,
New Hampshire, one month after the invasion of
Normandy.
This meeting to establish United Nations was held in
San Francisco and the charter was signed in June
1945 (after Germany's surrender).
UN came into existence in October 1945. The
Articles of Agreement of the IMF was signed in
December 1945. The next year, the By-laws were
adopted at a meeting in Savanna, Georgia (March
8-18, 1946).
Contents of the Articles of Agreement
• IMF was established to provide member
countries with the necessary funds to cover
short term balance of payments problems.
The Fund in turn received resources from
members who were allotted quotas.
• Initial quota: $8 billion (worth about $80
billion today)
(Total Quota = 238 billion SDR as of 2010,
doubled, reaching 476 billion SDR in 2011).
Par value and 1% band
Upon entering the Fund, a country submitted
a par value of its currency expressed in
terms of gold or in terms of the US dollar
using the weight of gold in effect on July 1,
1944 ($35 per troy oz).
All exchange transactions between member
countries were to be effected at a rate that
fluctuated within 1% band (which
approximates gold import/export points)
around the par values of the respective
currencies.
Article IV : Changing par value
Article IV: A member could change the par value of its
currency only to correct a fundamental disequilibrium in
its balance of payments, and only after consulting with the
Fund.
(However, speculators correctly anticipate such weak
currencies, making it more difficult for the monetary
authorities to defend them.)
In case the Fund objects a change, but the member devalues
its currency, then that member is ineligible to use Fund's
resources.
The Fund cannot formally propose a change of the par value
of a currency.
No objection to a change if the cumulative change is less
than 10% of the par value.
Article VI: allows members to control capital
movements.
Article VII: The Fund may declare a currency to be
scarce. If so, member countries are authorized to
impose exchange control over the scarce
currency.
Remark: A problem that appeared during the interwar period was that
unlike deficit countries, surplus countries were not under any pressure
to adjust their BP. A deficit country was compelled to take some kind of
action to restore equilibrium, but a surplus country can accumulate
reserves indefinitely. (This is still true even today. IMF monitors
currency practices of deficit countries that receive loans.)
Britain adopted deflationary policy in the 1920s, but the surplus countries
(US + France) did not participate in the adjustment process.
Article VIII forbids restrictions on current account
balances. Members are obligated to maintain the
convertibility of foreign held current account
balances (to facilitate trade).
Exceptions: Article VII + XIV
Article XIV allows a member country to retain
exchange control restrictions in effect when that
country entered the Fund. Once a member
country abolishes its exchange control over the
current payments and accepted the obligations of
Article VIII, then it cannot reimpose exchange
control without the approval of the Fund.
Remark: Most major countries in Europe accepted
the obligations of Article VIII by 1961. Japan came
under this article in 1964.
The remaining Article XIV countries are obligated to
consult annually with the Fund on exchange
controls, but the Fund has no power to abolish the
exchange control unilaterally. No scarce currency
declaration has been made.
Most nations outside the Communist bloc became
members of the IMF.
Borrowing under Bretton Woods
During the Bretton Woods era (1948-73),
world trade volume increased six-fold while
GWP tripled (from $7 trillion in 1950 to $21
trillion) . ⇒ Transctions demand for foreign
currencies increased 6 times but the gold
supply did not increase much. Per capita
US GDP doubled ($2,700 in 1950 to $5,400
in 1973 at the end of the Bretton Woods.)
• But the total international reserve increased
only by 3% during the same period. So
there developed an acute shortage of
international reserve assets. The US had
acquired the bulk of the world's gold. In
1946, the US held $26 billion worth of gold
(740 million ounces, world total = 6 billion
oz). Today, Treasury owns 260 million
ounces of gold (mostly in Fort Knox,
Denver, and West Point and a little bit at
FRB NY).
If the U.S. had exported Treasury bills, it
would have provided additional reserves for
the US. However, nations became
increasingly reluctant to hold $. Gradually,
the US stock of gold was depleted.
The Fund was the source of financing for a
member country experiencing a temporary
disequilibrium in its balance of payments.
These resources come from gold and
currency subscriptions of its members.
Reserve/Gold tranche / Credit tranche
Upon entering the Fund, each country was
allotted a quota in accordance with its
relative economic size.
Reserve (gold) tranche: 25% of quota was
paid to the Fund in gold (1944 US dollar).
Today, this must be paid in SDR or major
currencies ($, £, € and yen).
Credit tranche: 75% of quota was paid in the
currency's own currency.
Quota
In 1946, the Fund started with aggregate quotas of
$8 billion, 20% of world reserves. (Today, this
amount is worth roughly $100 billion) The quota
was raised in 1971. The largest quota was US:
$6.7 billion (21.9%): U.K. $2.8 billion (9.2%),
Germany, France 5%, Japan 4%. The quota was
increased several times.
In 1990 the quota was increased to $135 billion, still
equal to about 20% of world reserves.
In 2011, quota increased to SDR 477 billion
(about $677 billion). There have been no
increases thereafter.
Quota
The quota determines the voting power of a
member's executive director. (250 votes + 1 vote
for SDR100,000)
e.g., US = 17.75% ($65 billion), total = $366 billion
(as of 2009)
Total: 2.5 million votes (and growing).
US holding of gold: currently, about 8,000 tons
($160 billion at $40 per oz), or about 5% of the
world's total gold stock. (the world has about
190,000 tons in 2019, World Gold Council)
Jewelry: 90,000 tons, Investors: 40,000 tons,
governments: 33,000 tons
Borrowing
The size of a country's quota determines the
borrowing limit of that country.
(i) Basic Facility: gold tranche + 4 credit tranche =
125%
(ii) Extended Facility: 140%
(iii) Standby Agreements: Short term borrowing
member countries negotiate to receive the Fund's
guarantee. usually borrowing is for 3-5 years.
.
Borrowing
(iv) General Agreements to Borrow (GAB): was negotiated
in 1962 by the Group of Ten: France, Italy, Germany,
Belgium, Netherlands, Sweden, Japan, UK, US, Canada.
Switzerland joined in 1964. The fund could borrow up to
$5.9 billion from the Group of Ten to provide more short
term assistance.
(v) Currency Swap Arrangements : made in 1962. bilateral
arrangements between central banks. Purpose: to avoid
exchange control. At maturity, both parties re-exchange
the original amounts.
The total quota is small, not sufficient to deal with the
European crisis.
In 2008, Japan lent $100 billion to the IMF. US also extended
$100 billion line of credit.
SPECIAL DRAWING RIGHTS
Benefits of Reserve Currency
(i) avoid exchange rate risk: (a) Exchange rates
between two currencies can be volatile, dramatically
changing the prices of the goods. (b) Traders are
reluctant to use the currencies of small countries.
(ii) Other countries hold dollar balances for
transactions purposes ⇒They are lending money to
the US (interest-free loans, much like the commercial
banks paying no interest to checking account
balances). US firms have easier access to the
financial market. US has unlimited financing (Douglas
North, 1993 Nobel lecture)
Benefits of Reserve Currency
In particular, President of France, De Gaulle,
complained in 1965 that the US enjoys the
hegemony, using "worthless paper to plunder
other nation's resources and factories." (unlimited
financing)
Vladimir Putin: "US is a parasite on the world
economy." (Reuters, Aug 1, 2011). The Russia-
China currency swap has been ineffective due to
low demand for the Ruble.
Costs
US did not coerce any country to hold USD. USD has
been simply more reliable, and trading countries were
willing to hold USD. As the demand for the reserve
currency increases, and USD appreciates. ⇒ US
trade deficit increases.
In a certain sense, SDR allocations were like the credit
limits on a person's credit card or line of credit. SDRs
can be used to make payments to settle debts
between central banks.
In addition, each member country agreed to accept
three times its own SDR quota from other central
banks.
An agreement was reached at the IMF annual
meeting in Rio de Janeiro in 1967 to issue
SDRs to be allocated to 104 participants.
The first allocation was made in 1970 (3.4
billion), then 1971 (2.95 billion), 1972 (2.95
billion)
value of SDR
Originally, the value of an SDR was set at one US dollar,
both having the same weight in gold in 1970.
However, dollar was devalued a couple of times, and
there was a general move to end the key role of $ in
the international monetary system.
After July 1, 1974, the value of SDR was determined in
terms of "basket" of 16 main currencies. Weights:
USD = 33%, mark = 12.5%, pound = 9%, FF = 7.5%,
yen = 7.5%, CND = 6%, lira = 6%. From April 1980,
only 5 major currencies.
$ = 42%, DM = 19%, yen = 13%, FF = 13%, pound =
13% The value of SDR is calculated daily by IMF.
SDR included $, euro, pound and yen. 1 SDR =
$1.50 as of 2013
From October 1, 2016, five currencies are
included: USD, €, Renminbi, yen, £ (GBP).
Renminbi is not "freely convertible" in
international transactions.
Codes: USD, EUR, GBP, CNY, JPY, XDR
SDRs are merely bookkeeping entries. It
becomes a reserve asset because of the
commitment of participating countries to
accept SDRs up to an amount equal to 3 times
their own SDR allocations.
creation of SDR
A decision to create SDRs require the approval of a
majority of member countries holding 85% of the
weighted voting power of the Fund.
Once created, SDRs are distributed to participants
in proportion to Fund quotas. As of 2009, the total
allocation reached SDR 204 billion.
Between central banks
Unlike dollar and other currencies, SDRs are not
usable for private international transactions.
SDRs represent a net addition to international
reserve that are as useful as gold or dollars,
unlike international borrowing (which does
not change reserves). Since it costs nothing
to create SDRs, the world saves resources
that would otherwise be wasted to mine and
refine gold. For this reasons, SDRs are
sometimes called paper gold. However,
they should be called "e-Gold" (electronic
gold) since no paper notes are issued.
Importance
SDR plays a limited role as an international reserve
asset due to its small quantity relative to the daily
transactions volume (about $5 trillion dollars) in
the foreign exchange market. Its main function is
the unit of account of transactions of international
organizations and central banks.
SDR is not tied to any single currency., and hence
there is no need for the US to have large trade
deficits in order to provide more reserves to the
ROW.
SDRs can be created as needed to insure
stable growth of international reserves. If
SDRs replace $ as reserve assets in central
banks, the US does not have to be a world
banker. SDR makes the IMF an
international central bank.
interest rate
Once every year, the IMF charges every
country interest on allotment, and credits
every country with interest on the average
SDR holdings during the past year. The
interest rate was 1.5% per year originally,
but raised to 5% in 1975. Now it is
calculated weekly based on a weighted
average of short term interest rates in the
basket currencies (Euro, Yen, Pound
Sterling, USD). 1 SDR is about $1.5 in April
2014.
The Role of the US Dollar
The international monetary system evolved in a way
that was not foreseen in the Articles of Agreement
of IMF.
During the 1950s the USD increasingly took over
the function of gold as the major international
reserve asset.
Why hold dollar, not gold?
No one planned this development. The US was the
dominant world power. (US share of output: 50%
in 1950, 40% in 1960, but has been stable at 25%
since the 1980s
Well over half of all international money transactions
were financed in terms of dollar
The US also owned about two thirds of the official gold
reserve in the world in 1940.
The dollar became the dominant invoice currency. (The
US profits as the banker.) Most exporters invoiced the
importers in dollars. When the European countries
had reserve surpluses in the 1950s and early 1960s,
they converted the surpluses into dollar reserves
rather than gold because.
(i) interest could be earned on dollar assets, and
(ii) dollar reserves can always be converted into gold at
$35 per ounce whenever it became necessary.
All of the non-Communist countries maintained a stable
relationship between their currencies and the dollar
either directly or indirectly through the British pound.
The US dollar was at the center of this system. Since
the Great Britain had halted the gold convertibility of
its currency, US dollar was the only currency directly
convertible into gold for official purposes. Before
WWI, the pound sterling performed a similar function,
but the sterling area had shrunken to a small number
of countries.
As the Bretton Woods system evolved, the reserves of
most countries became a mixture of gold and dollars.
Over time, US dollar became increasingly more
important.
dollar as principal reserve asset
The US balance of payments was more important
than those of other countries, because other
countries were holding US dollar as the principal
reserve asset. Moreover, the US was unable to
eliminate ever-increasing trade deficits, which
undermined the Bretton Woods system.
External debts:
US: $18 trillion
EU: $14
UK: $7
Japan: $3
Five Ways to Correct BP
Deficits
(1) deflate the
economy
use contractionary Monetary policy
(raise interest rate) or Fiscal policy (cut
federal spending) to reduce aggregate
demand. This is a painful option
because the government will become
less popular. (e.g., Great Britain after
WWI)
A permanent but painful solution.
(2) devalue
As the price of the foreign currency (e)
rises, net exports = X(e) - M(e)
declines, which reduces trade deficit.
Five Ways to Correct BP Deficits
(3) impose exchange
control on current
account
An exchange control limits imports. A
temporary stopgap solution.
(4) deplete gold stock
A temporary remedy.
Since the stock of gold is limited, it
will soon run out.
Five Ways to Correct BP Deficits
(5) increase
liabilities to
foreign central
banks.
(6)The surplus
country (e.g.,
China) holds
more dollar
assets.
This means the US is unwilling to devalue $, or the
surplus country (e.g., China) is unwilling to let RMB
appreciate. A temporary solution, and eventually
the latter country gives up.
Instead of importing American goods, China buys
dollar assets. As China holds more dollar assets,
their value in RMB declines when RMB appreciates
(Chinese investors lose money: buy high, sell low)
China buys properties in the middle east, and
central Asia (Kazakhstan) (Silkroad Economic Belt,
2013)
China's trade/GDP ratio = 41% in 2015
US = 30%)
US Payments Deficit in the 1960s
Persistent US BP deficits in the 60s
In the 1960s the international monetary
system was shaken by a series of
disturbances in the foreign exchange and
gold markets.
Since the US dollar was used as the principal
reserve asset by our trading partners, the
weakness of dollar raised doubts about the
viability of the entire system.
Persistent US BP deficits in the 60s
During the period 1958-1971, the US experienced a
persistent deficit in its balance of payments. At
first, economists viewed these annual deficits as
temporary. However, it gradually dawned to policy
makers that the US deficits were not
disappearing. The causes of these chronic deficits
are:
(a) a higher rate of return r* > r, which results in
capital outflows.
(b) military commitments in Europe and Asia.
(c) The Vietnam war also caused inflation in the US.
International reserve assets of the US
During the years 1958-1971, the US experienced a
cumulative reserve deficit of $56 billion. International
reserve in other countries mainly consisted of US dollar
and gold, although the currencies of other major countries
were reserve assets but they played a minor role.
US reserve assets included foreign currencies such as Yen,
DM and British pound at first. However, by the end of the
1960s, the US international reserve consisted mainly of
gold.
Some of the fundamentals are wrong (p, w, r, Y, e). The first
best policy is a devaluation of USD. All other policies such
as lowering interest rates are second best.
Increasing liabilities to foreign central
banks
During this period (from 1958 to 1971), the
US not only witnessed a gradual depletion
of its international reserve assets but also a
dramatic increase in liabilities to foreign
central banks.
Gold Coverage of a currency
= Gold held by the Fed/Liabilities to Foreign
Central Banks
Gold coverage in 1963 Gold coverage in 1971
(a few months after Nixon’s
declaration of dollar’s
gold inconvertibility)
By 1963, the US gold reserve at FRB New
York (Manhattan) barely covered liabilities
to foreign central banks, and by 1970 the
gold coverage had fallen to 55%, by 1971
22%. Thus, from 1963, had the foreign
central banks tried to convert their dollar
reserves into gold, the US would have been
forced to abandon dollar's gold
convertibility.
Collapse of the Bretton Woods
Temporary measures
To lesson the outflow of private capital, the
US imposed an interest equalization tax
in 1963. This was effective to curb
temporarily the outflow of portfolio
investment. However, because r* > r, it was
more than offset by a big jump in US bank
loans to foreign borrowers and a further
growth in US direct investment.
(a) Voluntary Foreign Credit Restraint program was adopted
in 1965 (Canada and developing countries were
exempted). This was replaced by Mandatory Investment
Controls in 1968, lifted in 1975.
(b)Federal Reserve System entered into a series of
currency swap agreements with central banks of
Western Europe, Canada, and Japan. Under these
bilateral agreements, a foreign central bank provided
standby credit (in foreign currency) to the Federal Reserve
System in return for an equal amount of standby credit (in
dollar).
None of these measures reduced US basic deficit but
lessened the gold drain and dampened the speculative
capital outflows. President Nixon once raised the value of
dollar, to penalize the speculators. (It did not work).
Collapse of Bretton Woods
President Richard Nixon
The crisis of 1971 was caused by a gradual loss of
confidence in dollar. In 1970, funds began to
move at an enormous rate from the US dollar to
financial centers in Europe and Japan.
In May 1971, West Germany left the Bretton woods
system. Switzerland redeemed $50 million for
gold. In early August 1971, France sent a
battleship to New York harbor and took delivery of
$191 million in gold (Huffington Post).
Collapse of Bretton Woods
Then on August 11, the British ambassador
requested to redeem $3 billion for gold (1/3 of US
gold reserve, Tyler Durden) President Nixon
announced on August 15, 1971:
(i) a 90-day freeze on wages and prices
(ii)10% import surcharge on dutiable imports
(iii) suspension of dollar's convertibility into gold.
"Dollars for Oil" replaces "Dollars for
gold”
After the Yom Kippur war (October 6-25,
1973), in July 1974, Kissinger sent his
deputy William Simon to the Middle East.
Kissinger and Saudi royal family agreed:
(i) All of oil sales will be prices in USD
(Saudi's will not accept other currencies),
and invest surplus oil revenues in US
securities,
(ii) in return, US will protect Saudi's oil fields
and guarantee protection from Israel.
SMITHSONIAN AGREEMENT
International monetary negotiations were
undertaken within the framework of the Group of
Ten. Details were worked out by the Group of Ten
in a meeting at the Smithsonian Institution in
Washington DC in December 1971. The
agreement was then formalized by the IMF.
It was a temporary regime. The agreement
allowed member countries to vary their exchange
rates within margins of 2 ¼% on either side of the
central rates after currency realignment.
Currency realignment: Yen appreciated 17%, Mark
13.5 %, pound 9%, FF 9%. Par value of other
minor currencies were also changed. In return for
the revaluation of other currencies, the U.S.
agreed to raise the price of gold from $35 to $38
an ounce. This was equivalent to a dollar
devaluation of 8.57%.
This devaluation of dollar has no significance
because the dollar remains inconvertible. 10%
import surcharge was suppressed.
The collapse of the Bretton Woods system did not
generate a chaos as did the collapse of the
international gold standard in the 1930s.
The Smithsonian Agreement was a useless attempt
to perpetuate the adjustable peg system with a
new currency alignment.
Par Value Modification Act, 1973 (amended) With
the second devaluation of the dollar in March
1973 by 11% (the price of gold rose from $38.00
to $42.22 per ounce), the Smithsonian agreement
fell apart and other currencies were left to float
against the dollar. Bank of Japan absorbed a few
billion dollars in one week, but eventually quit.
The International Monetary Fund (IMF) is an
organization of 189 member countries, each of which
has representation on the IMF's executive board in
proportion to its financial importance, so that the
most powerful countries in the global economy have
the most voting power.
Objective
―Foster global monetary cooperation
―Secure financial stability
―Facilitate international trade
―Promote high employment and sustainable economic
growth
―And reduce poverty around the world
History
The IMF, also known as the Fund, was conceived at a
UN conference in Bretton Woods, New
Hampshire, United States, in July 1944.
The 44 countries at that conference sought to build a
framework for economic cooperation to avoid a
repetition of the competitive devaluations that had
contributed to the Great Depression of the 1930s.
Countries were not eligible for membership in the
International Bank for Reconstruction and
Development (IBRD) unless they were members of
the IMF.
IMF, as per Bretton Woods agreement to
encourage international financial cooperation,
introduced a system of convertible currencies at
fixed exchange rates, and replaced gold with the
U.S. dollar (gold at $35 per ounce) for official
reserve.
After the Bretton Woods system (system of fixed
exchange rates) collapsed in the 1971, the IMF
has promoted the system of floating exchange
rates. Countries are free to choose their
exchange arrangement, meaning that market
forces determine the value of currencies relative
to one another. This system continues to be in
place today.
During 1973 oil crisis, IMF estimated that
the foreign debts of 100 oil-importing
developing countries increased by 150%
between 1973 and 1977, complicated
further by a worldwide shift to floating
exchange rates. IMF administered a new
lending program during 1974–1976 called
the Oil Facility. Funded by oil-exporting
nations and other lenders, it was available
to nations suffering from acute problems
with their balance of trade due to the rise in
oil prices.
IMF was one of the key organisations of the
international economic system; its design
allowed the system to balance the rebuilding of
international capitalism with the maximisation of
national economic sovereignty and human
welfare, also known as embedded liberalism.
The IMF played a central role in helping the
countries of the former Soviet bloc transition from
central planning to market-driven economies.
In 1997, a wave of financial crises swept over
East Asia, from Thailand to Indonesia to Korea
and beyond. The International Monetary Fund
created a series of bailouts (rescue packages)
for the most-affected economies to enable them
to avoid default, tying the packages to currency,
banking and financial system reforms.
Global Economic Crisis (2008): IMF
undertook major initiatives to strengthen
surveillance to respond to a more
globalized and interconnected world.
These initiatives included revamping the
legal framework for surveillance to cover
spill-overs (when economic policies in one
country can affect others), deepening
analysis of risks and financial systems,
stepping up assessments of members’
external positions, and responding more
promptly to concerns of the members.
Functions
Provides Financial Assistance: To provide
financial assistance to member
countries with balance of payments
problems, the IMF lends money to
replenish international reserves,
stabilize currencies and strengthen
conditions for economic growth. Countries
must embark on structural adjustment
policies monitored by the IMF.
Functions
IMF Surveillance: It oversees the
international monetary system and
monitors the economic and financial
policies of its 189 member countries. As
part of this process, which takes place both
at the global level and in individual
countries, the IMF highlights possible risks
to stability and advises on needed policy
adjustments.
Functions
Capacity Development: It provides technical
assistance and training to central banks,
finance ministries, tax authorities, and other
economic institutions. This helps countries
raise public revenues, modernize banking
systems, develop strong legal frameworks,
improve governance, and enhance the
reporting of macroeconomic and financial
data. It also helps countries to make progress
towards the Sustainable Development
Goals (SDGs).
IMF Reforms
IMF Quota: a member can borrow up to 200
percent of its quota annually and 600 percent
cumulatively. However, access may be higher in
exceptional circumstances.
IMF quota simply means more voting rights and
borrowing permissions under IMF. But it is
unfortunate that IMF Quota’s formula is designed
in such a way that USA itself has 17.7% quota
which is higher than cumulative of several
countries. The G7 group contains more than 40%
quota where as countries like India & Russia
have only 2.5% quota in IMF.
Due to discontent with IMF, BRICS countries
established a new organization called BRICS bank
to reduce the dominance of IMF or World Bank and
to consolidate their position in the world as BRICS
countries accounts for 1/5th of WORLD GDP and
2/5th of world population.
It is almost impossible to make any reform in the
current quota system as more than 85% of total
votes are required to make it happen. The 85% votes
does not cover 85% countries but countries which
have 85% of voting power and only USA has voting
share of around 17% which makes it impossible to
reform quota without consent of developed countries.
2010 Quota Reforms approved by Board of
Governors were implemented in 2016 with
delay because of reluctance from US
Congress as it was affecting its share.
Combined quotas (or the capital that the
countries contribute) of the IMF increased to a
combined SDR 477 billion (about $659 billion)
from about SDR 238.5 billion (about $329
billion). It increased 6% quota share for
developing countries and reduced same
share of developed or over represented
countries.
More representative Executive Board:
2010 reforms also included an
amendment to the Articles of Agreement
established an all-elected Executive
Board, which facilitates a move to a more
representative Executive Board.
The 15th General Quota Review provides
an opportunity to assess the appropriate
size and composition of the Fund’s
resources and to continue the process of
governance reforms.
• One proposed reform is a movement towards
close partnership with other specialist agencies
such as UNICEF, the Food and Agriculture
Organization (FAO), and the United Nations
Development Program (UNDP).
• IMF loan conditions should be paired with other
reforms—e.g., trade reform in developed
nations, debt cancellation, and increased
financial assistance for investments in basic
infrastructure.
• COVID-19 Financial Assistance and Debt
Service Relief
• The IMF is providing financial assistance and
debt service relief to member countries facing
the economic impact of the COVID-19 pandemic.
overview of assistance approved by the IMF’s
Executive Board since late March 2020 under its
various lending facilities and debt service relief
financed by the Catastrophe Containment and
Relief Trust (CCRT). Overall, the IMF is currently
making about $250 billion, a quarter of its $1
trillion lending capacity, available to member
countries.
As part of the COVID19-related rapid arrangements,
borrowing countries have committed to undertake
governance measures to promote accountable and
transparent use of these resources.
Total Debt Relief for 29 Countries:
1st Tranche: SDR 183.13 million / US$ 251.24 million
2nd Tranche: SDR 168.40 million / US$ 237.46 million
3rd Tranche: SDR 168.07 million / US$ 238.05 million
Debt service relief total: SDR 519.60 million / US$ 726.75
million
https://www.imf.org/en/Topics/imf-and-
covid19/COVID-Lending-Tracker#APD
Total Financial Assistance for 85 Countries:
SDR 81,715.40 million / US$ 113,067.08 million
The Executive Board of the International Monetary
Fund (IMF) today approved a disbursement to
the Central Bank of Solomon Islands for an
amount of SDR 20.8 million (about US$28.5
million, 100 percent of quota), comprising SDR
6.93 million (about US$ 9.5 million, 33.3 percent
of quota) under the Rapid Credit Facility (RCF)
and SDR 13.87 million (about US$ 19 million,
66.7 percent of quota) under the Rapid
Financing Instrument (RFI) to help cover urgent
balance of payments needs stemming from the
COVID-19 pandemic.
The Rapid Financing Instrument (RFI) provides
rapid financial assistance, which is available to
all member countries facing an urgent balance of
payments need.
The RFI was created as part of a broader reform to
make the IMF’s financial support more flexible to
address the diverse needs of member countries.
The RFI replaced the IMF’s previous emergency
assistance policy and can be used in a wide
range of circumstances.
The Rapid Credit Facility (RCF) provides rapid
concessional financial assistance with limited
conditionality to low-income countries (LICs) facing
an urgent balance of payments need.
The RCF was created under the Poverty Reduction
and Growth Trust (PRGT) as part of a broader
reform to make the Fund’s financial support more
flexible and better tailored to the diverse needs of
LICs, including in times of crisis.
The RCF places emphasis on the country’s poverty
reduction and growth objectives.
Financing under the RCF carries a zero interest rate,
has a grace period of 5½ years, and a final maturity
of 10 years.
IMF and India
International regulation by IMF in the field of
money has certainly contributed towards
expansion of international trade. India has,
to that extent, benefitted from these fruitful
results.
Post-partition period, India had serious
balance of payments deficits, particularly
with the dollar and other hard currency
countries. It was the IMF that came to her
rescue.
The Fund granted India loans to meet the financial
difficulties arising out of the Indo–Pak conflict of
1965 and 1971.
From the inception of IMF up to March 31, 1971,
India purchased foreign currencies of the value
of Rs. 817.5 crores from the IMF, and the same
have been fully repaid.
Since 1970, the assistance that India, as other
member countries of the IMF, can obtain from it
has been increased through the setting up of the
Special Drawing Rights (SDRs created in
1969).
India had to borrow from the Fund in the wake of the steep
rise in the prices of its imports, food, fuel and fertilizers.
In 1981, India was given a massive loan of about Rs. 5,000
crores to overcome foreign exchange crisis resulting from
persistent deficit in balance of payments on current
account.
India has availed of the services of specialists of the IMF
for the purpose of assessing the state of the Indian
economy. In this way India has had the benefit of
independent scrutiny and advice.
The balance of payments position of India having gone
utterly out of gear on account of the oil price escalation
since October 1973, the IMF has started making
available oil facility by setting up a special fund for the
purpose.
India wanted large foreign capital for her
various river projects, land reclamation
schemes and for the development of
communications. Since private foreign
capital was not forthcoming, the only
practicable method of obtaining the
necessary capital was to borrow from the
International Bank for Reconstruction
and Development (i.e. World Bank).
Early 1990s when foreign exchange reserves – for two
weeks’ imports as against the generally accepted 'safe
minimum reserves' of three month equivalent —
position were terribly unsatisfactory. Government of
India's immediate response was to secure an emergency
loan of $2.2 billion from the International Monetary Fund
by pledging 67 tons of India's gold reserves as collateral
security. India promised IMF to launch several structural
reforms (like devaluation of Indian currency, reduction in
budgetary and fiscal deficit, cut in government expenditure and
subsidy, import liberalisation, industrial policy reforms, trade
policy reforms, banking reforms, financial sector reforms,
privatization of public sector enterprises, etc.) in the coming
years.
• The foreign reserves started picking up
with the onset of the liberalisation policies.
• India has occupied a special place in the
Board of Directors of the Fund. Thus,
India had played a creditable role in
determining the policies of the Fund.
This has increased the India’s prestige in
the international circles.
Evaluations of International Monetary System
Gold Standard:
Gold has historically been used as a medium of
exchange primarily due to its scarce availability and
desirable properties. Besides its durability, portability,
and ease of standardization, the high production
costs of the yellow metal make it costly for
governments to manipulate short-run changes in its
stock.
As gold is commodity money, it tends to promote price
stability in the long run. Thus, the purchase power of
an ounce of gold will tend toward equality with its
long-run cost of production.
The various versions of gold standards used
were:
Gold specie standard:
The actual currency in circulation consists of gold
coins with fixed gold content.
Gold bullion standard:
The currency in circulation consists of paper notes
but a fixed weight of gold remains the basis of
money. Any amount of paper currency can be
converted into gold and vice versa by the
country’s monitory authority at a fixed conversion
ratio.
Gold exchange standard:
Paper currency can be converted at a fixed rate into
the paper currency of the other country, if it is
operating a gold specie or gold bullion standard.
Such an exchange regime was followed in the post-
Bretton Woods era.
Exchange rates from 1876 to 1913 were generally
dictated by gold standards. Each country backed up
its currency with gold, and currencies were
convertible into gold at specified rates. Relative
convertibility rates of the currencies per ounce of
gold determined the exchange rates between the
two currencies.
Gold standard was suspended following World War I in 1914 and
governments financed massive military expenditure by printing
money. This led to a sharp rise both in the supply of money
and market prices. Hyperinflation in Germany presents a
classic example where the price index rapidly shot from 262 in
1919 to 12,61,60,00,00,00,000 (a factor of 481.5 billion) in
December 1923.
The US and some other countries returned to gold standards so
as to achieve financial stability, but following the Great
Depression in 1930, gold standards were finally abandoned.
Some countries attempted to peg their currencies to the US
dollar or British pound in the 1930s but there were frequent
revisions.
This followed severe restrictions on international transactions and
instability in the foreign exchange market, leading to a decline
in the volume of international trade during this period.
Fixed Exchange Rates:
In July 1944, representatives of 44 allied nations
agreed to a fixed rate monetary system and setting
up of the International Monetary Fund in a
conference held in Bretton Woods, New Hampshire.
Each member country pledged to maintain a fixed or
pegged exchange rate for its currency vis-a-vis gold
or the US dollar.
Since the price of each currency was fixed in terms of
gold, their values with respect to each other were
also fixed. For instance, price of one ounce of gold
was fixed equal to US$35. This exchange regime,
following the Bretton Woods Conference, was
characterized as the Gold Exchange Standard.
In the Bretton Woods era, which lasted from 1944
to 1971, fixed exchange rates were maintained
by government intervention in the foreign
exchange markets so that the exchange rates
did not drift beyond 1 per cent of their initially
established levels.
Under the Bretton Woods system, the US dollar
effectively became the international currency.
Other countries accumulated and held US dollars
for making international payments whereas the
US could pay internationally in its own currency.
By 1971, the foreign demand for the US
dollar was substantially less than the
supply and it appeared to be overvalued.
On 15 August 1971 the US government
abandoned its commitment to convert the
US dollar into gold at the fixed price of
US$35 per ounce and the major currencies
went on a float.
In an attempt to revamp the monetary
system, consequent to a conference of
various countries’ representatives, the
Smithsonian Agreement was concluded in
December 1971, which called for a
devaluation of US dollar by 8 per cent
against other currencies and pegging the
official price of gold to US$38 per ounce.
Besides, 2.25 per cent fluctuations in either
direction were also allowed in the newly
set exchange rates.
Pros and cons of fixed exchange rate
system:
Under the fixed exchange rate system,
international managers can operate their
international trade and business activities
without worrying about future rates.
However, companies do face
repercussions of currency devaluation both
by their home and the host countries.
Further, the currency of each country
becomes more vulnerable to economic
upheavals in other countries.
Floating Exchange Rate System:
Even after the Smithsonian Agreement,
governments still faced difficulty in maintaining
their exchange rates within the newly
established exchange rates regime. By March
1973, the fixed exchange rate system was
abandoned and the world officially moved to a
system of floating exchange rates.
Under the freely floating exchange rate system,
currency prices are determined by market
demand and supply conditions without the
intervention of the governments.
Pros and cons of floating exchange rates:
A country under the floating exchange rate system
is more insulated from inflation, unemployment,
and economic upheavals prevalent in other
countries. Thus, the problems faced in one
country need not be contagious to another.
The adjustment of exchange rates serves as a form
of protection against exporting economic
problems to other countries. Besides, the central
bank of a country is not required to constantly
maintain the exchange rates within the specified
limits and to make frequent interventions.
Although other countries are reasonably
insulated from the problems faced by one
country under the freely floating exchange
rates, the exchange rates themselves can
further aggravate the economic woes of a
country plagued by economic problems
and unemployment.
This possibility makes it essential for
international managers to devote
substantial resources to measure and
manage the exposure to exchange rate
fluctuations.
Special Drawing Rights (SDR)
Special drawing rights (SDRs) are supplementary foreign
exchange reserve assets defined and maintained by
the International Monetary Fund (IMF)
SDR is not a currency, instead represents a claim to
currency held by IMF member countries for which they
may be exchanged.
The value of an SDR is defined by a weighted currency
basket of four major currencies: the US dollar, the euro,
the British pound, the Chinese Yuan and the Japanese
yen
Central bank of member countries held SDR with IMF which
can be used by them to access funds from IMF in case of
financial crises in their domestic market
Controversy over Regulation of International
Finance
As the global market expands, the need for
international regulation becomes urgent. Since
World War II, financial crises have been the
result of macroeconomic instability until the
fatidic week end of September 15 2008, when
Lehman Brothers filed for bankruptcy. The
financial system had become the source of its
own instability through a combination of greed,
lousy underwriting, fake ratings and
regulatory negligence.
Controversy over Regulation of International
Finance
From that date, governments tried to put together a
new regulatory framework that would avoid using
taxpayer money for bailout of banks.
In an uncoordinated effort, they produced a series
of vertical regulations that are disconnected from
one another. That will not be sufficient to stop
finance from being instable and the need for
international and horizontal regulation is urgent.
Developing Countries' Concerns,
in three areas where further change is certainly
needed:
-First, the international financial architecture, where
important reforms have been made, but where
the hard work of implementation still lies ahead;
-Second, in international financial regulation, where
there is more work to do to ensure that the right
incentives are in place for financial institutions in
developed and developing markets to manage
their risks more effectively in future; and
-
Developing Countries' Concerns,
Third, in emerging market countries
themselves, where there is a need for
more practical efforts to upgrade
accounting and legal standards, and
systems of financial regulation, and of
course to clean up the balance sheets of
banking systems which, in many cases,
remain very fragile.
The main elements of that quiet
revolution are:
- much more outreach for banking
supervisors, above all to supervisors in
emerging markets;
- increasing acceptance by all supervisors
that core principles of supervision,
rigorously applied in all countries of the
world, are essential;
- increasing acceptance of the need for
external monitoring to ensure compliance
with those core principles;
- a willingness by supervisors to work much
more closely than before with the financial
institutions as the leaders of that
monitoring exercise;
- greater willingness by supervisors to work
more closely with each other across
borders and across traditional sectors of
banking, securities and insurance;
-a willingness by the Fund and the Bank to take on
the rôle of monitoring and to integrate financial
sector surveillance and reconstruction much
more closely into their work; and
-a desire by the international financial community to
consider more carefully the threats to financial
stability, to put in place better incentives for
avoiding such crises, and to bring together the
key government officials, supervisors, central
banks and the financial institutions, through the
new Financial Stability Forum.
Exchange Rate Policy of Developing
Economies.
An exchange rate, as a price of one country's
money in terms of another's, is among the most
important prices in an open economy. It
influences the flow of goods, services, and
capital in a country, and exerts strong pressure
on the balance of payments, inflation and other
macroeconomic variables. Therefore, the choice
and management of an exchange rate regime is
a critical aspect of economic management to
safeguard competitiveness, macro economic
stability, and growth
Exchange Rate Policy of Developing Economies.
The choice of an appropriate exchange rate regime
for developing countries has been at the center
of the debate in international finance for a long
time.
―What are the costs and benefits of various
exchange rate regimes?
―What are the determinants of the choice of an
exchange rate regime and how would country
circumstances affect the choice?
― Does macroeconomic performance differ under
alternative regimes?
―How would an exchange rate adjustment affect
trade flows?
The steady increase in magnitude and variability of
international capital flows has intensified the
debate in the past few years as each of the
major currency crises in the 1990s has in some
way involved a fixed exchange rate and sudden
reversal of capital inflows.
New questions include:
―Are pegged regimes inherently crisis-prone?
― Which regimes would be better suited to deal
with increasingly global and unstable capital
markets?
While today almost every advanced nation has a
flexible exchange rate regime similar to that
advocated by Milton Friedman, most emerging
countries continue to have ‘conventional peg’.
Historical work of Milton Friedman examined the
conditions under which he thought that flexible
rates were the right system for developing
countries, and when he thought that it was
appropriate to have an alternative regime.
The currency crises in Lebanon, Turkey, and
Argentina have once again brought to the fore
the question of the optimal exchange rate regime
in an emerging country.
Almost 70 years ago, Milton Friedman published
“The case for flexible exchange rates”
(Friedman 1953).
In it he argued that a system of ‘pegged but
adjustable’ parities was highly unstable and
made a strong pitch for flexible exchange rates
regimes.
While today almost every advanced nation has a
flexible exchange rate regime similar to the one
advocated by Friedman, most emerging
countries continue to have ‘conventional peg’
(IMF 2019).
What Friedman’s views on currency and monetary
regimes in developing countries were. In a 1973
Congressional testimony, Friedman said:
“[w]hile I have long been in favor of a system
of floating exchange rates for the major
countries, I have never argued that that is
necessarily also the best system for the
developing countries.”
Milton Friedman in India: 1955 and 1963
In 1955, Milton Friedman traveled to India to advise
the Nehru government. He prepared a short
memorandum that covered, among other things,
the exchange rate issue. At the time, foreign
exchange was rationed and allocated in a
discretionary fashion.
Friedman wrote that there were only two ways to
deal with external imbalances: “First, to inflate or
deflate internally in response to a putative
surplus or deficit in the balance of payments;
Milton Friedman in India: 1955 and 1963
second, to permit the exchange rate to fluctuate…
[a method] that has been adopted by Canada
with such conspicuous success” (Friedman
1955).
He added that if a completely free float was ruled
out (for political reasons), an auction system was
a solid second-best solution. This would allow
“purchasers to use it for anything they wish and
in any currency area they wish.”
Friedman returned to India in 1965. This time he
was particularly critical of the Bretton Woods’
pegged-but-adjustable regime. A mere
devaluation, he stated, was not a solution in a
country with chronic inflation. In a lecture
delivered in Mumbai he said: “The temptation will
be to change its [the rupee’s] value from its
present level… and then try to hold it at the new
fixed level. That would be another mistake. Even
if the new exchange rates are correct when
established, once you pegged them, there is no
assurance that they will indefinitely remain
correct” (Friedman 1968).
The ten regimes are arranged under the following four
relatively homogeneous groups
(a) Floating regimes (independent floating, lightly
managed float);
(b) Intermediate regimes (managed float, crawling
broad band);
(c) Soft peg reglmes (crawling narrow band, crawling
peg, pegged within bands, fixed peg); and
(d) Hard peg regimes (currency board, currency
union/dollarization).
The floating regimes would be an appropriate choice for medium and
large industrialized countries and some emerging market economies
that have import and export sectors that are relatively small
compared to GDP, but are fully integrated in the global capital
markets and have diversified production and trade, a deep and broad
financial sector, and strong prudential standards. The hard peg
regimes are more appropriate for countries satisfying the optimum
currency area criteria (countries in the European Economic and
Monetary Union), small countries already integrated in a larger
neighboring country (dollarization in Panama), or countries with a
history of monetary disorder, high inflation, and low credibility of
policymakers to maintain stability that need a strong anchor for
monetary stabilization (currency board in Argentina and Bulgaria).
The soft peg regimes would be best for countries with
limited links to international capital markets, less
diversified production and exports, and shallow financial
markets, as well as countries stabilizing from high and
protracted inflation under an exchange rate-based
stabilization program (Turkey). These are largely but not
exclusively non emerging market developing countries .
The intermediate regimes, a middle road between
floating rates and soft pegs, aim to incorporate the
benefits of floating and pegged regimes while avoiding
their shortcomings.
The macroeconomic authorities of developing and transition
countries are faced with a difficult task.
On the one hand, the global economy is unstable with
frequent shocks, crises and volatilities. It is also a place
with fierce competition with multinational corporations of
EU, US, Japan and Korea, the emergence of China as
the factory of the world, dumping and unfair trade
practices by some exporters, etc.
On the other hand, the domestic capability of most
developing and transition countries is still weak. The
market economy is not well developed, and domestic
enterprises lack competitiveness. The government is
often saddled with inefficiency, corruption, lack of
expertise, and political pressure.
The question for the central bank governor and the
finance minister is: how do you manage monetary
policy, and especially the exchange rate, in order to avoid
unnecessary shocks and provide stable environment for
economic development? More specifically, in this age of
accelerated globalization, what is the appropriate
exchange rate system for developing or transition
countries?
The question is difficult enough, but to make the
matter even more complicated, there are many
policy goals but only one exchange rate.
If a country has the multiple exchange rate
system, the IMF will not seriously deal with
you and FDI will probably not come. It is a
good idea to unify the rates as soon as
possible.
China unified their rates in 1994 and Vietnam
did so in 1989. Unification did not give
them any big shock, and they began to
receive large amounts of FDI after that,
partly because of the improved exchange
rate system.
The government is often concerned about
the social consequences of currency
reunification, but people are usually much
better off with a unified rate than without.
The persistence of the multiple exchange
rate practice is mainly a political problem,
not economic. It is a huge and hidden
subsidy and taxation system, from which
some people benefit greatly.
The possible goals for exchange rate
management may include the following:
1. Competitiveness
2. Price stability
3. Current account adjustment
4. Domestic financial stability (protection of
balance sheets of banks and firms)
5. Public debt management
6. Avoiding speculative attacks
7. Minimizing domestic impact of a large
exogenous shock (like a regional conflict or
currency crisis)
8. Promoting FDI, growth, or industrialization
The first two goals--competitiveness and
price stability--are very fundamental and
all countries should mind them. The big
problem is that these two goals often
conflict with each other.
To maintain competitiveness (or regain it
after domestic inflation), the exchange rate
should be flexible and devaluation must be
accepted, if necessary.
On the other hand, to contain domestic
inflation or avoid imported inflation, the
exchange rate should be either stable or
even moderately overvalued (this is called
the use of the exchange rate as a nominal
anchor).
But clearly, these two requirements are not
compatible.
it keeps the exchange rate stable, it will exert a deflationary
pressure on the domestic economy so the inflation-
devaluation spiral can be avoided. But in this case,
competitiveness is lost due to overvaluation, and a
recession is likely.
The third goal--current account adjustment--is
popular but controversial. Traditionally,
devaluation is recommended to a country with a
current account (or trade) deficit. However,
whether it really works to reduce the deficit or not
must be carefully studied in the context of each
individual country. Devaluation is a double-edged
sword; as noted above, it may trigger an inflation
spiral. It may also affect the macroeconomy in
other complicated ways to offset the intended
relative-price effect
The fourth and fifth goals--protecting the
balance sheets of the private and public
sectors--are related to the question of
exchange exposure and losses. If the
currency is devalued, the value of foreign
currency-denominated debt will increase in
home currency, which creates enormous
difficulties for both the private and public
sectors. Part of this debt can be hedged,
but not all
The sixth goal--avoiding speculative attacks--can be
achieved by calming the market expectation. How can we
do this? Some economists argue that the exchange rate
should float.
Exchange rate flexibility will remind traders that the currency
can go both up as well as down, which discourages them
from betting on exchange rate stability or one-way
movement. This makes attacks less likely.
But exchange rate volatility itself may become a problem.
Perhaps the best way to avoid attacks is to avoid
overvaluation, and that is attained by frequent reviews
and proper adjustments of the exchange rate levels (i.e.,
fulfilling the competitiveness concern).
The seventh goal--minimizing impact of a large
external crisis--essentially is the question of the
timing and manner of floating. If the currency of
an important neighboring country collapses, your
currency becomes suddenly overvalued,
relatively speaking. The government must decide
whether the home currency should (partly) follow
this depreciation or remain stable.
There is no easy rule of thumb as to whether you
should float earlier, later, or not at all; it depends
on individual cases.
The eighth goal--promoting FDI, growth,
or industrialization--is, in my view, a red
herring. Such long-term real-sector
development goals cannot be pursued by
exchange rate management. The only
thing that the central bank can do for this
purpose is to maintain competitiveness
and price stability (namely, doing well in
the first two goals).
Managed float
After the Mexican (1994) and the Asian
(1997) crises, many economists began to
argue that dollar peg was dangerous. They
contend that exchange rates should be
flexible enough so adjustments are not
delayed until too late. Some even argue
that IMF should not lend to countries with a
dollar peg !
Bipolar view
Some economists--Barry Eichengreen, Stanley
Fischer and others--went even further.
According to them, the reality of the 21st century
with massive financial flows would not allow any
country to adopt a "middle" solution such as
target zones, adjustable peg, baskets, crawling
peg, etc.
They recommend that all countries, including
developing and transition ones, to converge on
either complete fix or 100% free floating.
Currency board
The currency board is an institutional arrangement to
tie money supply closely to the amount of
international reserves, so the monetary authority has
no power to issue money independently (in principle,
at least).
In the most rigid case, monetary base can be issued or
withdrawn only in exchange with foreign assets sold
or bought against the monetary authority (however,
most currency boards are not so rigid; there are
loopholes and lee ways).
With a currency board, monetary policy is not needed
so the central bank is abolished and a simpler
"monetary authority" takes over.
Dollarization
dollarization has two meanings.
Private (or inadvertent) dollarization:
people use dollars because they do not
trust domestic money or foreign money is
more convenient than domestic money.
Official dollarization: the government
declares USD to be the only official money
for the country, and abolishes domestic
money.
Multiple currency basket (proposed for East
Asia)
multiple currency baskets consisting of
dollar, yen and euro are recommended by
some economists to the developing
countries in East Asia.
These baskets are supposed to
automatically smooth the competitiveness
shocks arising from the movements of
major currencies (but they do not
automatically adjust for other shocks
Soft dollar zone (for East Asia)
Ronald McKinnon argues that neither floating
nor the currency basket is practical in East
Asia.
He notes that East Asian currencies actually
returned to the soft dollar peg after the
Asian crisis, the situation which he thinks is
desirable and reasonable.
The dollar is the key currency in the world
economy and monetary stability should be
built around it.
Virtual exchange rate stability
This is also proposed by Prof. McKinnon
(especially for major countries). There should be
a long-term, unchanging nominal exchange rate
target based on tradable PPP (for example,
$1=110 yen).
The two countries (for example, Japan and the US)
have the obligation to keep the rate within the
narrow band around this target forever. When a
large shock hits occasionally (once in a
decade?), the rate can deviate temporarily from
the target.
But after the shock is gone, the rate must return to
the original, unchanged band.
Double target zones
John Williamson (Institute of International
Economics, Washington DC) is the
champion of target zone proposals. He has
many ideas, and the double target zone is
one of them. There should be a "soft" inner
band and a "hard" outer band, so the
central bank will have three zones where
(i) it does not intervene; (ii) it can intervene;
and (iii) it must intervene.
Band-basket-crawl (BBC)
This idea, advanced by Rudiger Dornbusch
and Y. C. Park, is a variation of the target
zone proposal. The central rate should be
defined by a multiple currency basket and
there should be a band around it.
Moreover, there is a built-in inflation sliding
of the central rate. This is what I would call
a currency basket with inflation slide.
"Eclectic" view
Jeffrey Frankel wrote a paper entitled: "No
single currency regime is right for all
countries or at all times." The right choice
depends on circumstances, and each
country should adopt the most suitable
system for itself. The attempt to find a one-
size-fits-all solution is misguided.
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4
208 gwes unit 4

More Related Content

What's hot

International financial system
International financial systemInternational financial system
International financial systemVikram g b
 
World Trade Organization - WTO - International Business - Manu Melwin Joy
World Trade Organization - WTO - International Business - Manu Melwin JoyWorld Trade Organization - WTO - International Business - Manu Melwin Joy
World Trade Organization - WTO - International Business - Manu Melwin Joymanumelwin
 
Chapter 18 International Finance
Chapter 18 International FinanceChapter 18 International Finance
Chapter 18 International FinanceAlamgir Alwani
 
Meeting 1 - Introduction to international economics (International Economics)
Meeting 1 - Introduction to international economics (International Economics)Meeting 1 - Introduction to international economics (International Economics)
Meeting 1 - Introduction to international economics (International Economics)Albina Gaisina
 
The history of international monetary system
The history of international monetary systemThe history of international monetary system
The history of international monetary systemSuleyman Ally
 
International trade notes
International trade notes International trade notes
International trade notes Mrdasilvasjha
 
Foreign exchange market
Foreign exchange marketForeign exchange market
Foreign exchange marketVisakhapatnam
 
International monetary system
International monetary systemInternational monetary system
International monetary systemSachin Paurush
 
Interest rate parity 1
Interest rate parity 1Interest rate parity 1
Interest rate parity 1Anshu Singh
 
History of International Monetary Systems - A quick and dirty guide
History of International Monetary Systems - A quick and dirty guideHistory of International Monetary Systems - A quick and dirty guide
History of International Monetary Systems - A quick and dirty guideVikas Sharma
 

What's hot (20)

Functions of wto
Functions of wtoFunctions of wto
Functions of wto
 
International financial system
International financial systemInternational financial system
International financial system
 
Monetary policy
Monetary policyMonetary policy
Monetary policy
 
International debt problem
International debt problemInternational debt problem
International debt problem
 
Modern Theory of International Trade
Modern Theory of International TradeModern Theory of International Trade
Modern Theory of International Trade
 
Imf
ImfImf
Imf
 
World Trade Organization - WTO - International Business - Manu Melwin Joy
World Trade Organization - WTO - International Business - Manu Melwin JoyWorld Trade Organization - WTO - International Business - Manu Melwin Joy
World Trade Organization - WTO - International Business - Manu Melwin Joy
 
Chapter 18 International Finance
Chapter 18 International FinanceChapter 18 International Finance
Chapter 18 International Finance
 
Meeting 1 - Introduction to international economics (International Economics)
Meeting 1 - Introduction to international economics (International Economics)Meeting 1 - Introduction to international economics (International Economics)
Meeting 1 - Introduction to international economics (International Economics)
 
The history of international monetary system
The history of international monetary systemThe history of international monetary system
The history of international monetary system
 
International trade notes
International trade notes International trade notes
International trade notes
 
Introduction of international trade
Introduction of international tradeIntroduction of international trade
Introduction of international trade
 
Foreign exchange market
Foreign exchange marketForeign exchange market
Foreign exchange market
 
Foreign exchange market
Foreign exchange marketForeign exchange market
Foreign exchange market
 
Economics:Economic Integration
Economics:Economic IntegrationEconomics:Economic Integration
Economics:Economic Integration
 
Devaluation Marshall Learner Approach
Devaluation Marshall Learner ApproachDevaluation Marshall Learner Approach
Devaluation Marshall Learner Approach
 
International monetary system
International monetary systemInternational monetary system
International monetary system
 
International monetary system
International monetary systemInternational monetary system
International monetary system
 
Interest rate parity 1
Interest rate parity 1Interest rate parity 1
Interest rate parity 1
 
History of International Monetary Systems - A quick and dirty guide
History of International Monetary Systems - A quick and dirty guideHistory of International Monetary Systems - A quick and dirty guide
History of International Monetary Systems - A quick and dirty guide
 

Similar to 208 gwes unit 4

EvaluatingtheintlmonetarysystemandtheavailtomovetowardsoneMohammedIbrahim
EvaluatingtheintlmonetarysystemandtheavailtomovetowardsoneMohammedIbrahimEvaluatingtheintlmonetarysystemandtheavailtomovetowardsoneMohammedIbrahim
EvaluatingtheintlmonetarysystemandtheavailtomovetowardsoneMohammedIbrahimMohammed Ibrahim
 
Chap. 3. international monetary system
Chap. 3. international monetary systemChap. 3. international monetary system
Chap. 3. international monetary systemScarlett Voughn
 
Cleo Bonny reading ambassador killer presentation skills international financ...
Cleo Bonny reading ambassador killer presentation skills international financ...Cleo Bonny reading ambassador killer presentation skills international financ...
Cleo Bonny reading ambassador killer presentation skills international financ...Cleo Bonny
 
International monetary regimes
International monetary regimesInternational monetary regimes
International monetary regimesWai Mar Soe
 
International monetory system
International monetory systemInternational monetory system
International monetory systemSharath Kumar Ps
 
The Globalization of World Economics.pptx
The Globalization of World Economics.pptxThe Globalization of World Economics.pptx
The Globalization of World Economics.pptxCabildoNeilAndreiT
 
A small airline recently sold to a private equity group for $145 m.docx
A small airline recently sold to a private equity group for $145 m.docxA small airline recently sold to a private equity group for $145 m.docx
A small airline recently sold to a private equity group for $145 m.docxannetnash8266
 
ReformingtheglobalmonetarysystembyMohammedIbrahim
ReformingtheglobalmonetarysystembyMohammedIbrahimReformingtheglobalmonetarysystembyMohammedIbrahim
ReformingtheglobalmonetarysystembyMohammedIbrahimMohammed Ibrahim
 
M03 eiteman0136091008 12_mbf_c03
M03 eiteman0136091008 12_mbf_c03M03 eiteman0136091008 12_mbf_c03
M03 eiteman0136091008 12_mbf_c03satluy
 
International finance
International financeInternational finance
International financeelvism
 
The international monetary fund
The international monetary fundThe international monetary fund
The international monetary fundRohit Thareja
 
Swimming in a Sea of Finance: the Occasional Logic of Capital Controls
Swimming in a Sea of Finance: the Occasional Logic of Capital ControlsSwimming in a Sea of Finance: the Occasional Logic of Capital Controls
Swimming in a Sea of Finance: the Occasional Logic of Capital ControlsJonathon Flegg
 
Module 2- The Global Economy.docx
Module 2- The Global Economy.docxModule 2- The Global Economy.docx
Module 2- The Global Economy.docxSheila Tipon
 

Similar to 208 gwes unit 4 (20)

EvaluatingtheintlmonetarysystemandtheavailtomovetowardsoneMohammedIbrahim
EvaluatingtheintlmonetarysystemandtheavailtomovetowardsoneMohammedIbrahimEvaluatingtheintlmonetarysystemandtheavailtomovetowardsoneMohammedIbrahim
EvaluatingtheintlmonetarysystemandtheavailtomovetowardsoneMohammedIbrahim
 
Chap. 3. international monetary system
Chap. 3. international monetary systemChap. 3. international monetary system
Chap. 3. international monetary system
 
Cleo Bonny reading ambassador killer presentation skills international financ...
Cleo Bonny reading ambassador killer presentation skills international financ...Cleo Bonny reading ambassador killer presentation skills international financ...
Cleo Bonny reading ambassador killer presentation skills international financ...
 
Important
ImportantImportant
Important
 
International monetary regimes
International monetary regimesInternational monetary regimes
International monetary regimes
 
International monetory system
International monetory systemInternational monetory system
International monetory system
 
Internatinal inventory system
Internatinal inventory systemInternatinal inventory system
Internatinal inventory system
 
Chap011
Chap011Chap011
Chap011
 
Bretton woods system
Bretton woods systemBretton woods system
Bretton woods system
 
A maze-sixth edition
A maze-sixth editionA maze-sixth edition
A maze-sixth edition
 
The Globalization of World Economics.pptx
The Globalization of World Economics.pptxThe Globalization of World Economics.pptx
The Globalization of World Economics.pptx
 
Chap03.ppt
Chap03.pptChap03.ppt
Chap03.ppt
 
A small airline recently sold to a private equity group for $145 m.docx
A small airline recently sold to a private equity group for $145 m.docxA small airline recently sold to a private equity group for $145 m.docx
A small airline recently sold to a private equity group for $145 m.docx
 
ReformingtheglobalmonetarysystembyMohammedIbrahim
ReformingtheglobalmonetarysystembyMohammedIbrahimReformingtheglobalmonetarysystembyMohammedIbrahim
ReformingtheglobalmonetarysystembyMohammedIbrahim
 
M03 eiteman0136091008 12_mbf_c03
M03 eiteman0136091008 12_mbf_c03M03 eiteman0136091008 12_mbf_c03
M03 eiteman0136091008 12_mbf_c03
 
International finance
International financeInternational finance
International finance
 
The international monetary fund
The international monetary fundThe international monetary fund
The international monetary fund
 
Swimming in a Sea of Finance: the Occasional Logic of Capital Controls
Swimming in a Sea of Finance: the Occasional Logic of Capital ControlsSwimming in a Sea of Finance: the Occasional Logic of Capital Controls
Swimming in a Sea of Finance: the Occasional Logic of Capital Controls
 
Module 2- The Global Economy.docx
Module 2- The Global Economy.docxModule 2- The Global Economy.docx
Module 2- The Global Economy.docx
 
Wolf
WolfWolf
Wolf
 

More from ASM's IBMR- Chinchwad

M.B.A. 206 FIN PERSONAL FINANCIAL PLANNING(OCT 2022).pdf
M.B.A. 206 FIN PERSONAL FINANCIAL PLANNING(OCT 2022).pdfM.B.A. 206 FIN PERSONAL FINANCIAL PLANNING(OCT 2022).pdf
M.B.A. 206 FIN PERSONAL FINANCIAL PLANNING(OCT 2022).pdfASM's IBMR- Chinchwad
 
MBA 206 FIN PERSONAL FINANCIAL PLANNING APRIL 2023.pdf
MBA 206 FIN  PERSONAL FINANCIAL PLANNING APRIL 2023.pdfMBA 206 FIN  PERSONAL FINANCIAL PLANNING APRIL 2023.pdf
MBA 206 FIN PERSONAL FINANCIAL PLANNING APRIL 2023.pdfASM's IBMR- Chinchwad
 
108 INDIAN ECONOMYUnitwise QuestionBank.pdf
108 INDIAN ECONOMYUnitwise QuestionBank.pdf108 INDIAN ECONOMYUnitwise QuestionBank.pdf
108 INDIAN ECONOMYUnitwise QuestionBank.pdfASM's IBMR- Chinchwad
 
Import Export Documentation and Procedures.pdf
Import Export Documentation and Procedures.pdfImport Export Documentation and Procedures.pdf
Import Export Documentation and Procedures.pdfASM's IBMR- Chinchwad
 
International Business Environment.pdf
International Business Environment.pdfInternational Business Environment.pdf
International Business Environment.pdfASM's IBMR- Chinchwad
 
208 - Geopolitics & World Economic Systems UNIT 1
208 - Geopolitics & World Economic Systems UNIT 1208 - Geopolitics & World Economic Systems UNIT 1
208 - Geopolitics & World Economic Systems UNIT 1ASM's IBMR- Chinchwad
 
103 Economic Analysis for Business Decisions mcq bhati
103 Economic Analysis for Business Decisions mcq bhati103 Economic Analysis for Business Decisions mcq bhati
103 Economic Analysis for Business Decisions mcq bhatiASM's IBMR- Chinchwad
 
208 - Geopolitics & World Economic Systems MCQ 23
208 - Geopolitics & World Economic Systems MCQ 23208 - Geopolitics & World Economic Systems MCQ 23
208 - Geopolitics & World Economic Systems MCQ 23ASM's IBMR- Chinchwad
 
208 - Geopolitics & World Economic Systems MCQ 2
208 - Geopolitics & World Economic Systems MCQ 2208 - Geopolitics & World Economic Systems MCQ 2
208 - Geopolitics & World Economic Systems MCQ 2ASM's IBMR- Chinchwad
 
208 - Geopolitics & World Economic Systems mcq 1
208 - Geopolitics & World Economic Systems mcq 1208 - Geopolitics & World Economic Systems mcq 1
208 - Geopolitics & World Economic Systems mcq 1ASM's IBMR- Chinchwad
 

More from ASM's IBMR- Chinchwad (20)

M.B.A. 206 FIN PERSONAL FINANCIAL PLANNING(OCT 2022).pdf
M.B.A. 206 FIN PERSONAL FINANCIAL PLANNING(OCT 2022).pdfM.B.A. 206 FIN PERSONAL FINANCIAL PLANNING(OCT 2022).pdf
M.B.A. 206 FIN PERSONAL FINANCIAL PLANNING(OCT 2022).pdf
 
MBA 206 FIN PERSONAL FINANCIAL PLANNING APRIL 2023.pdf
MBA 206 FIN  PERSONAL FINANCIAL PLANNING APRIL 2023.pdfMBA 206 FIN  PERSONAL FINANCIAL PLANNING APRIL 2023.pdf
MBA 206 FIN PERSONAL FINANCIAL PLANNING APRIL 2023.pdf
 
108 INDIAN ECONOMYUnitwise QuestionBank.pdf
108 INDIAN ECONOMYUnitwise QuestionBank.pdf108 INDIAN ECONOMYUnitwise QuestionBank.pdf
108 INDIAN ECONOMYUnitwise QuestionBank.pdf
 
108INDIANECONOMY.pdf
108INDIANECONOMY.pdf108INDIANECONOMY.pdf
108INDIANECONOMY.pdf
 
Import Export Documentation and Procedures.pdf
Import Export Documentation and Procedures.pdfImport Export Documentation and Procedures.pdf
Import Export Documentation and Procedures.pdf
 
301strategic management.pdf
301strategic management.pdf301strategic management.pdf
301strategic management.pdf
 
International Business Environment.pdf
International Business Environment.pdfInternational Business Environment.pdf
International Business Environment.pdf
 
Ibe307 unit4b
Ibe307 unit4b Ibe307 unit4b
Ibe307 unit4b
 
international business environment
international business environment international business environment
international business environment
 
Deloittle placement orinteation
Deloittle placement orinteationDeloittle placement orinteation
Deloittle placement orinteation
 
208 - Geopolitics & World Economic Systems UNIT 1
208 - Geopolitics & World Economic Systems UNIT 1208 - Geopolitics & World Economic Systems UNIT 1
208 - Geopolitics & World Economic Systems UNIT 1
 
103 Economic Analysis for Business Decisions mcq bhati
103 Economic Analysis for Business Decisions mcq bhati103 Economic Analysis for Business Decisions mcq bhati
103 Economic Analysis for Business Decisions mcq bhati
 
208 - Geopolitics & World Economic Systems MCQ 23
208 - Geopolitics & World Economic Systems MCQ 23208 - Geopolitics & World Economic Systems MCQ 23
208 - Geopolitics & World Economic Systems MCQ 23
 
208 - Geopolitics & World Economic Systems MCQ 2
208 - Geopolitics & World Economic Systems MCQ 2208 - Geopolitics & World Economic Systems MCQ 2
208 - Geopolitics & World Economic Systems MCQ 2
 
208 - Geopolitics & World Economic Systems mcq 1
208 - Geopolitics & World Economic Systems mcq 1208 - Geopolitics & World Economic Systems mcq 1
208 - Geopolitics & World Economic Systems mcq 1
 
208 gwes unit5c
208 gwes unit5c208 gwes unit5c
208 gwes unit5c
 
208 gwes unit 4c
208 gwes unit 4c208 gwes unit 4c
208 gwes unit 4c
 
208 gwes unit 4b
208 gwes unit 4b208 gwes unit 4b
208 gwes unit 4b
 
208 gwes unit 4b
208 gwes unit 4b208 gwes unit 4b
208 gwes unit 4b
 
208 gwes unit 4a
208 gwes unit 4a208 gwes unit 4a
208 gwes unit 4a
 

Recently uploaded

一比一原版(Caltech毕业证书)加州理工学院毕业证成绩单学位证书
一比一原版(Caltech毕业证书)加州理工学院毕业证成绩单学位证书一比一原版(Caltech毕业证书)加州理工学院毕业证成绩单学位证书
一比一原版(Caltech毕业证书)加州理工学院毕业证成绩单学位证书atedyxc
 
1. Elemental Economics - Introduction to mining
1. Elemental Economics - Introduction to mining1. Elemental Economics - Introduction to mining
1. Elemental Economics - Introduction to miningNeal Brewster
 
Satoshi DEX Leverages Layer 2 To Transform DeFi Ecosystem.pdf
Satoshi DEX Leverages Layer 2 To Transform DeFi Ecosystem.pdfSatoshi DEX Leverages Layer 2 To Transform DeFi Ecosystem.pdf
Satoshi DEX Leverages Layer 2 To Transform DeFi Ecosystem.pdfcoingabbar
 
Managing personal finances wisely for financial stability and
Managing personal finances wisely for financial stability  andManaging personal finances wisely for financial stability  and
Managing personal finances wisely for financial stability andraqibmifysolutions
 
Tourism attractions in Lesotho katse dam
Tourism attractions in Lesotho katse damTourism attractions in Lesotho katse dam
Tourism attractions in Lesotho katse dammataekepule
 
L1 2024 Prequisite QM persion milad1371.pdf
L1 2024 Prequisite QM persion milad1371.pdfL1 2024 Prequisite QM persion milad1371.pdf
L1 2024 Prequisite QM persion milad1371.pdfmiladsojoudi211
 
Solution Manual For Financial Statement Analysis, 13th Edition By Charles H. ...
Solution Manual For Financial Statement Analysis, 13th Edition By Charles H. ...Solution Manual For Financial Statement Analysis, 13th Edition By Charles H. ...
Solution Manual For Financial Statement Analysis, 13th Edition By Charles H. ...rightmanforbloodline
 
Shrambal_Distributors_Newsletter_May-2024.pdf
Shrambal_Distributors_Newsletter_May-2024.pdfShrambal_Distributors_Newsletter_May-2024.pdf
Shrambal_Distributors_Newsletter_May-2024.pdfvikashdidwania1
 
一比一原版(UC Davis毕业证书)加州大学戴维斯分校毕业证成绩单学位证书
一比一原版(UC Davis毕业证书)加州大学戴维斯分校毕业证成绩单学位证书一比一原版(UC Davis毕业证书)加州大学戴维斯分校毕业证成绩单学位证书
一比一原版(UC Davis毕业证书)加州大学戴维斯分校毕业证成绩单学位证书atedyxc
 
amil baba in australia amil baba in canada amil baba in london amil baba in g...
amil baba in australia amil baba in canada amil baba in london amil baba in g...amil baba in australia amil baba in canada amil baba in london amil baba in g...
amil baba in australia amil baba in canada amil baba in london amil baba in g...israjan914
 
一比一原版(UCSD毕业证书)加利福尼亚大学圣迭戈分校毕业证成绩单学位证书
一比一原版(UCSD毕业证书)加利福尼亚大学圣迭戈分校毕业证成绩单学位证书一比一原版(UCSD毕业证书)加利福尼亚大学圣迭戈分校毕业证成绩单学位证书
一比一原版(UCSD毕业证书)加利福尼亚大学圣迭戈分校毕业证成绩单学位证书atedyxc
 
20240514-Calibre-Q1-2024-Conference-Call-Presentation.pdf
20240514-Calibre-Q1-2024-Conference-Call-Presentation.pdf20240514-Calibre-Q1-2024-Conference-Call-Presentation.pdf
20240514-Calibre-Q1-2024-Conference-Call-Presentation.pdfAdnet Communications
 
The Pfandbrief Roundtable 2024 - Covered Bonds
The Pfandbrief Roundtable 2024 - Covered BondsThe Pfandbrief Roundtable 2024 - Covered Bonds
The Pfandbrief Roundtable 2024 - Covered BondsNeil Day
 
一比一原版(WashU毕业证书)圣路易斯华盛顿大学毕业证成绩单学位证书
一比一原版(WashU毕业证书)圣路易斯华盛顿大学毕业证成绩单学位证书一比一原版(WashU毕业证书)圣路易斯华盛顿大学毕业证成绩单学位证书
一比一原版(WashU毕业证书)圣路易斯华盛顿大学毕业证成绩单学位证书atedyxc
 
asli amil baba bengali black magic kala jadu expert in uk usa canada france c...
asli amil baba bengali black magic kala jadu expert in uk usa canada france c...asli amil baba bengali black magic kala jadu expert in uk usa canada france c...
asli amil baba bengali black magic kala jadu expert in uk usa canada france c...israjan914
 
Economic Risk Factor Update: May 2024 [SlideShare]
Economic Risk Factor Update: May 2024 [SlideShare]Economic Risk Factor Update: May 2024 [SlideShare]
Economic Risk Factor Update: May 2024 [SlideShare]Commonwealth
 
GIFT City Overview India's Gateway to Global Finance
GIFT City Overview  India's Gateway to Global FinanceGIFT City Overview  India's Gateway to Global Finance
GIFT City Overview India's Gateway to Global FinanceGaurav Kanudawala
 
Jual obat aborsi Jogja ( 085657271886 ) Cytote pil telat bulan penggugur kand...
Jual obat aborsi Jogja ( 085657271886 ) Cytote pil telat bulan penggugur kand...Jual obat aborsi Jogja ( 085657271886 ) Cytote pil telat bulan penggugur kand...
Jual obat aborsi Jogja ( 085657271886 ) Cytote pil telat bulan penggugur kand...Klinik kandungan
 
Amil baba australia kala jadu in uk black magic in usa
Amil baba australia kala jadu in uk black magic in usaAmil baba australia kala jadu in uk black magic in usa
Amil baba australia kala jadu in uk black magic in usaisrajan914
 

Recently uploaded (20)

一比一原版(Caltech毕业证书)加州理工学院毕业证成绩单学位证书
一比一原版(Caltech毕业证书)加州理工学院毕业证成绩单学位证书一比一原版(Caltech毕业证书)加州理工学院毕业证成绩单学位证书
一比一原版(Caltech毕业证书)加州理工学院毕业证成绩单学位证书
 
1. Elemental Economics - Introduction to mining
1. Elemental Economics - Introduction to mining1. Elemental Economics - Introduction to mining
1. Elemental Economics - Introduction to mining
 
Satoshi DEX Leverages Layer 2 To Transform DeFi Ecosystem.pdf
Satoshi DEX Leverages Layer 2 To Transform DeFi Ecosystem.pdfSatoshi DEX Leverages Layer 2 To Transform DeFi Ecosystem.pdf
Satoshi DEX Leverages Layer 2 To Transform DeFi Ecosystem.pdf
 
Managing personal finances wisely for financial stability and
Managing personal finances wisely for financial stability  andManaging personal finances wisely for financial stability  and
Managing personal finances wisely for financial stability and
 
SAUDI ARABIYA | +966572737505 |Jeddah Get Cytotec pills for Abortion pills
SAUDI ARABIYA | +966572737505 |Jeddah Get Cytotec pills for Abortion pillsSAUDI ARABIYA | +966572737505 |Jeddah Get Cytotec pills for Abortion pills
SAUDI ARABIYA | +966572737505 |Jeddah Get Cytotec pills for Abortion pills
 
Tourism attractions in Lesotho katse dam
Tourism attractions in Lesotho katse damTourism attractions in Lesotho katse dam
Tourism attractions in Lesotho katse dam
 
L1 2024 Prequisite QM persion milad1371.pdf
L1 2024 Prequisite QM persion milad1371.pdfL1 2024 Prequisite QM persion milad1371.pdf
L1 2024 Prequisite QM persion milad1371.pdf
 
Solution Manual For Financial Statement Analysis, 13th Edition By Charles H. ...
Solution Manual For Financial Statement Analysis, 13th Edition By Charles H. ...Solution Manual For Financial Statement Analysis, 13th Edition By Charles H. ...
Solution Manual For Financial Statement Analysis, 13th Edition By Charles H. ...
 
Shrambal_Distributors_Newsletter_May-2024.pdf
Shrambal_Distributors_Newsletter_May-2024.pdfShrambal_Distributors_Newsletter_May-2024.pdf
Shrambal_Distributors_Newsletter_May-2024.pdf
 
一比一原版(UC Davis毕业证书)加州大学戴维斯分校毕业证成绩单学位证书
一比一原版(UC Davis毕业证书)加州大学戴维斯分校毕业证成绩单学位证书一比一原版(UC Davis毕业证书)加州大学戴维斯分校毕业证成绩单学位证书
一比一原版(UC Davis毕业证书)加州大学戴维斯分校毕业证成绩单学位证书
 
amil baba in australia amil baba in canada amil baba in london amil baba in g...
amil baba in australia amil baba in canada amil baba in london amil baba in g...amil baba in australia amil baba in canada amil baba in london amil baba in g...
amil baba in australia amil baba in canada amil baba in london amil baba in g...
 
一比一原版(UCSD毕业证书)加利福尼亚大学圣迭戈分校毕业证成绩单学位证书
一比一原版(UCSD毕业证书)加利福尼亚大学圣迭戈分校毕业证成绩单学位证书一比一原版(UCSD毕业证书)加利福尼亚大学圣迭戈分校毕业证成绩单学位证书
一比一原版(UCSD毕业证书)加利福尼亚大学圣迭戈分校毕业证成绩单学位证书
 
20240514-Calibre-Q1-2024-Conference-Call-Presentation.pdf
20240514-Calibre-Q1-2024-Conference-Call-Presentation.pdf20240514-Calibre-Q1-2024-Conference-Call-Presentation.pdf
20240514-Calibre-Q1-2024-Conference-Call-Presentation.pdf
 
The Pfandbrief Roundtable 2024 - Covered Bonds
The Pfandbrief Roundtable 2024 - Covered BondsThe Pfandbrief Roundtable 2024 - Covered Bonds
The Pfandbrief Roundtable 2024 - Covered Bonds
 
一比一原版(WashU毕业证书)圣路易斯华盛顿大学毕业证成绩单学位证书
一比一原版(WashU毕业证书)圣路易斯华盛顿大学毕业证成绩单学位证书一比一原版(WashU毕业证书)圣路易斯华盛顿大学毕业证成绩单学位证书
一比一原版(WashU毕业证书)圣路易斯华盛顿大学毕业证成绩单学位证书
 
asli amil baba bengali black magic kala jadu expert in uk usa canada france c...
asli amil baba bengali black magic kala jadu expert in uk usa canada france c...asli amil baba bengali black magic kala jadu expert in uk usa canada france c...
asli amil baba bengali black magic kala jadu expert in uk usa canada france c...
 
Economic Risk Factor Update: May 2024 [SlideShare]
Economic Risk Factor Update: May 2024 [SlideShare]Economic Risk Factor Update: May 2024 [SlideShare]
Economic Risk Factor Update: May 2024 [SlideShare]
 
GIFT City Overview India's Gateway to Global Finance
GIFT City Overview  India's Gateway to Global FinanceGIFT City Overview  India's Gateway to Global Finance
GIFT City Overview India's Gateway to Global Finance
 
Jual obat aborsi Jogja ( 085657271886 ) Cytote pil telat bulan penggugur kand...
Jual obat aborsi Jogja ( 085657271886 ) Cytote pil telat bulan penggugur kand...Jual obat aborsi Jogja ( 085657271886 ) Cytote pil telat bulan penggugur kand...
Jual obat aborsi Jogja ( 085657271886 ) Cytote pil telat bulan penggugur kand...
 
Amil baba australia kala jadu in uk black magic in usa
Amil baba australia kala jadu in uk black magic in usaAmil baba australia kala jadu in uk black magic in usa
Amil baba australia kala jadu in uk black magic in usa
 

208 gwes unit 4

  • 1. Unit 4. International Monetary System 4. International Monetary System: The International Financial System - Reform of International Monetary Affairs - The Bretton Wood System and the International Monetary Fund, Controversy over Regulation of International Finance, Developing Countries' Concerns, Exchange Rate Policy of Developing Economies.
  • 2. International Financial System The international financial system (IFS) constitutes the full range of interest‐ and return‐bearing assets, bank and nonbank financial institutions, financial markets that trade and determine the prices of these assets, and the nonmarket activities (e.g., private equity transactions, private equity/hedge fund joint ventures, leverage buyouts whether bank financed or not, etc.) through which the exchange of financial assets can take place. The IFS lies at the heart of the global credit creation and allocation process.
  • 3. To be sure, the IFS depends on the effective functioning and prudent management of the IMS and the ready availability of currencies to support the payment system. Nevertheless, the IFS extends far beyond IMS’s common payments and currency pricing role to encompass the full range of financial assets, including derivatives, credit classes and the institutions that engage in the exchange of these assets as well as their regulatory and governing bodies. The IFS encompasses the IMS — but extends in function and complexity well beyond the IMS.
  • 4. Government debt links the two systems, as government debt can function as “near money” in a zero interest rate environment. Many financial transactions pass through a stage of payment in money (i.e., a demand deposit) — quickly —to a “riskless” interest‐bearing asset, like government bonds. When “riskless” assets become more “risky” and less liquid, the payment system slows down and may even be upended.
  • 5. Three features of the international financial system in the 21 st century: ―the currency system, ―capital flows, ―the responsibilities of authorities in the major economies.
  • 6. (1) The international monetary system (how exchange rates, balance of payments and macroeconomic management are managed and adjusted globally) is part of a broader international regime. As such, it is influenced strongly by the way power is distributed and exercised in the world, as well as the presence or absence of a powerful and reliable leader country.
  • 7. (2) Over time, international monetary systems exhibit oscillation between two opposites: for example, (i) general floating versus general fixity, (ii) stability versus instability, and (iii) free capital mobility versus no such mobility. It is hard to say which situation is normal and which is abnormal. People often believe that the prevailing system is normal and permanent, but it usually isn't. Whether capital mobility has become irreversible in the 21st century is an interesting and open question.
  • 8. (3) "The triangle of impossibility": Consider (i) exchange rate stability (i.e., fixed exchange rates), (ii) monetary policy independence, and (iii) free capital mobility. These three things are regarded as desirable, but only two can be realized at any time. Different international monetary systems emerge depending on which one we give up. For example, if we abandon the first, we have a floating rate system; and if the second is removed, monetary union like EU will emerge, and so on.
  • 9. (4) Since the 19th century, there has been a gradual movement away from commodity money (typically gold) toward paper money (managed currency). The problem with gold is its quantity is too constraining, which is also a merit if the central bank is irresponsible. In the 21st century, maybe we will have e-money which has completely new characteristics (and risks).
  • 10. The Currency System The safest judgment is that the currency system will continue to evolve along with the evolution of the international financial system. Article IV of the IMF Articles of Agreement calls upon members to assure orderly exchange rate arrangements and to promote a stable system of exchange rates not a stable exchange rate system.
  • 11. The Currency System In a rapidly changing international financial system, the search for comprehensive approaches to global exchange rate systems is likely to be unrewarding. When it comes to exchange rate regimes, there are no panaceas. It is easy to demonstrate that there is no single regime that is best for any national economy under all economic and financial circumstances; the disturbances with which regimes must cope change over time.
  • 12. The Currency System National authorities have to make choices about which regime on balance will best serve their economies; because changes in regimes are not costless. Eclecticism also is not a realistic option. Similarly no global currency system promises to serve best the interests of the global financial system under all conditions.
  • 13. The economic case for a trade bloc rests on the observation that ex ante trade barriers are high; the establishment of the trade bloc serves on balance to reduce trade distortions, creating more trade than is diverted. Currency blocs, on the other hand, run the risk of increasing distortions through the erection of barriers to the free flows of finance where few exist today, at least among the major currencies and financial markets.
  • 14. Capital Flows Consider a regime with a common global currency. Under such a regime, as with national monetary systems, capital flows would not be immune from irrational exuberance or despondence, and crises would continue to be possible.
  • 15. At a pragmatic level, responding to potential problems associated with international capital flows by the imposition of controls on those flows is likely over time to prove to be inefficient (and, therefore, costly), ineffective, or both, unless the national financial market itself is tightly controlled or highly underdeveloped. Moreover, as countries develop and grow, controls are relaxed and financial systems are opened up.
  • 16. Better response to the potential problems associated with international capital flows lies in the promotion of sound macroeconomic policies, flexible markets, robust financial systems supported by appropriate regulations and supervision, transparency about regimes and institutions, and adherence to agreed global standards.
  • 17. Responsibilities of Authorities in the Major Economies In order to provide support for the appropriate evolution of the international financial system in the 21 st century, the authorities in the major economies should implement sound macroeconomic and structural policies, demonstrate their respect for market forces, and endeavor to follow a policy of inclusion when it comes to establishing the rules and principles that will guide and govern the financial system. All this may sound like very little, but it is remarkable how taxing it is to accomplish these tasks effectively and successfully.
  • 18. The United Nations Monetary and Financial Conference, commonly known as Bretton Woods conference, was held in Bretton Woods, New Hampshire, USA to regulate the international monetary and financial order after the conclusion of World War II. The aim was to help rebuild the shattered post-war economy ( WW2 had just finished in 1945) and to promote international economic cooperation.
  • 19. The conference resulted in the agreements to set up the International Bank for Reconstruction and Development (IBRD)- popularly known as World Bank and the International Monetary Fund (IMF). The IMF was set up to foster monetary stability at global level. The IBRD was created to speed up post-war reconstruction. The two institutions are known as the Bretton Woods twins.
  • 20. Origins of Bretton Woods Political origin lies in 2 key conditions – Shared experiences of 2 World Wars, with the sense that failure to deal with economic problems after the first war had led to the second <Treaty of Versailles demanding massive reparation amount from Germany being the cause of collapse of German economy and Hitler’s rise to power> The concentration of power in a small number of states (US and Western Europe)
  • 21. Members of Bretton Woods Family aka Bretton Woods Twins 1. International Monetary Fund(IMF) – To maintain global financial stability through technical assistance, training, and loans to member states to tide over short term balance of payment crisis 2. World Bank (WB) Group – Consisting of 5 agencies which provides vital financial and technical assistance to developing countries around the world to reduce global poverty Remember that WTO has nothing to so with Bretton Woods. It officially commenced only in 1995 under the Marrakesh agreement and replace General Agreement on Tariff and trade (GATT)
  • 22. The Bretton Woods System is a set of unified rules and policies that provided the framework necessary to create fixed international currency exchange rates. Essentially, the agreement called for the newly created IMF to determine the fixed rate of exchange for currencies around the world. Every represented country assumed the responsibility of upholding the exchange rate, with incredibly narrow margins above and below. Countries struggling to stay within the window of the fixed exchange rate could petition the IMF for a rate adjustment, which all allied countries would then be responsible for following. The system was depended on and was used heavily until the beginning of the 1970s.
  • 23. The Collapse of the Bretton Woods System Backing currency by the gold standard started to become a serious problem throughout the late 1960s. By 1971, the issue was so bad that US President Richard Nixon gave notification that the ability to convert the dollar to gold was being suspended “temporarily.” The move was inevitably the final straw for the system and the agreement that outlined it. Still, there were several attempts by representatives, financial leaders, and governmental bodies to revive the system and keep the currency exchange rate fixed. However, by 1973, nearly all major currencies had begun to float relatively toward one another, and the entire system eventually collapsed.
  • 24. A brief World War II Timeline Adolf Hitler demanded that Gdansk be given to Germany, claiming that Gdansk residents were predominantly German. Backed by France and Britain, Poland refused. With this excuse, Germany invaded Poland on September 1, 1939. Recall that the representatives of the US and its Allies worked out three post-war arrangements (i) ITO (still-born), replaced by GATT and WTO. (ii) IBRD (which became the World Bank), and (iii) IMF, immediately after the Normandy invasion in June 1944.
  • 25. Stable and adjustable exchange rates For 25 years after WWII, the international monetary system known as the Bretton Woods system, was based on stable and adjustable exchange rates. Exchange rates were not permanently fixed, but occasional devaluations of individual currencies were allowed to correct fundamental disequilibria in the balance of payments (BP). Ever-increasing attack on the dollar in the 1960s culminated in the collapse of the Bretton Woods system in 1971, and it was reluctantly replaced with a regime of floating exchange rates.
  • 26. loss of national sovereignty • By signing the agreement, nations were submitting their exchange rates to international disciplines. • This amounted to a significant surrender of national sovereignty to an international organization. • Territorial waters = 12 nautical miles. US navy ships patrolled near Spratly archipelago on international waters (outside 12 nm).
  • 27. Advantages over the gold exchange standard Deflationary policy: Under the gold exchange standard, a country has to resort to the classical medicine of deflating the domestic economy when faced with chronic BP deficits. Before World War II, European nations often used this policy, in particular the Great Britain. Even though few currencies were convertible into gold, policy makers thought that currencies should be backed by gold and willingly adopted deflationary policies after WWI.
  • 28. Advantages over the gold exchange standard Deflationary policy is not the only option when faced with BP deficits. Devaluation is accepted in Bretton Woods. The adjustable peg was viewed as a vast improvement over the gold exchange standard with fixed parity. Currencies were convertible into gold, but unlike the gold exchange standard, countries had the ability to change par values of their currencies . For this reason, Keynes described the Bretton Woods system as "the exact opposite of the gold standard." The world economy tripled in size during the two decades, but gold supply did not change much.
  • 29. Unanticipated Problems Structural problems: (i) Over time the world economy grew and needed more liquidity or reserve assets. ⇒ Marshall Plan Aid. Gate of Honor, Versaille Palace "Wir wollen Kohle, Wir wollen Brot" (We want coal, We want bread). (former) President Herbert Hoover (1947): The whole economy of Europe is interlinked with German economy through the exchange of raw materials and manufactured goods.) (ii)
  • 30. Unanticipated Problems (ii) Given the fixed quantity of gold (192,000 tons or 6.2 billion ounces, annual production of gold = 80 million ounces = $100 billion), other countries had to hold US dollar and gold as reserve. Keynes had proposed that a world reserve currency be created and managed by a central bank. (Today IMF manages SDR.) (iii) As the world economy grew, the increased world demand for dollar as reserve assets meant that US had to incur increasing trade deficits.
  • 31. Unanticipated Problems The dollar was the numéraire of the system, i.e., it was the standard to which every other currency was pegged. Accordingly, the U.S. did not have the power to set the exchange rate between the dollar and any other currency. Changing the value of dollar in terms of gold has no real effect, because the parities of other currencies were pegged to the dollar. This is the n-th currency problem. This problem would not have existed if most of other currencies were pegged to gold. However, none of these currencies were pegged to gold because they were not convertible into gold. (limited supply of gold)
  • 32. Invasion of Normandy (June 6, 1944) International Monetary Fund and World Bank meeting was held in July 1944 in Bretton Woods, New Hampshire, one month after the invasion of Normandy. This meeting to establish United Nations was held in San Francisco and the charter was signed in June 1945 (after Germany's surrender). UN came into existence in October 1945. The Articles of Agreement of the IMF was signed in December 1945. The next year, the By-laws were adopted at a meeting in Savanna, Georgia (March 8-18, 1946).
  • 33. Contents of the Articles of Agreement • IMF was established to provide member countries with the necessary funds to cover short term balance of payments problems. The Fund in turn received resources from members who were allotted quotas. • Initial quota: $8 billion (worth about $80 billion today) (Total Quota = 238 billion SDR as of 2010, doubled, reaching 476 billion SDR in 2011).
  • 34. Par value and 1% band Upon entering the Fund, a country submitted a par value of its currency expressed in terms of gold or in terms of the US dollar using the weight of gold in effect on July 1, 1944 ($35 per troy oz). All exchange transactions between member countries were to be effected at a rate that fluctuated within 1% band (which approximates gold import/export points) around the par values of the respective currencies.
  • 35. Article IV : Changing par value Article IV: A member could change the par value of its currency only to correct a fundamental disequilibrium in its balance of payments, and only after consulting with the Fund. (However, speculators correctly anticipate such weak currencies, making it more difficult for the monetary authorities to defend them.) In case the Fund objects a change, but the member devalues its currency, then that member is ineligible to use Fund's resources. The Fund cannot formally propose a change of the par value of a currency. No objection to a change if the cumulative change is less than 10% of the par value.
  • 36. Article VI: allows members to control capital movements. Article VII: The Fund may declare a currency to be scarce. If so, member countries are authorized to impose exchange control over the scarce currency. Remark: A problem that appeared during the interwar period was that unlike deficit countries, surplus countries were not under any pressure to adjust their BP. A deficit country was compelled to take some kind of action to restore equilibrium, but a surplus country can accumulate reserves indefinitely. (This is still true even today. IMF monitors currency practices of deficit countries that receive loans.) Britain adopted deflationary policy in the 1920s, but the surplus countries (US + France) did not participate in the adjustment process.
  • 37. Article VIII forbids restrictions on current account balances. Members are obligated to maintain the convertibility of foreign held current account balances (to facilitate trade). Exceptions: Article VII + XIV Article XIV allows a member country to retain exchange control restrictions in effect when that country entered the Fund. Once a member country abolishes its exchange control over the current payments and accepted the obligations of Article VIII, then it cannot reimpose exchange control without the approval of the Fund.
  • 38. Remark: Most major countries in Europe accepted the obligations of Article VIII by 1961. Japan came under this article in 1964. The remaining Article XIV countries are obligated to consult annually with the Fund on exchange controls, but the Fund has no power to abolish the exchange control unilaterally. No scarce currency declaration has been made. Most nations outside the Communist bloc became members of the IMF.
  • 39. Borrowing under Bretton Woods During the Bretton Woods era (1948-73), world trade volume increased six-fold while GWP tripled (from $7 trillion in 1950 to $21 trillion) . ⇒ Transctions demand for foreign currencies increased 6 times but the gold supply did not increase much. Per capita US GDP doubled ($2,700 in 1950 to $5,400 in 1973 at the end of the Bretton Woods.)
  • 40. • But the total international reserve increased only by 3% during the same period. So there developed an acute shortage of international reserve assets. The US had acquired the bulk of the world's gold. In 1946, the US held $26 billion worth of gold (740 million ounces, world total = 6 billion oz). Today, Treasury owns 260 million ounces of gold (mostly in Fort Knox, Denver, and West Point and a little bit at FRB NY).
  • 41. If the U.S. had exported Treasury bills, it would have provided additional reserves for the US. However, nations became increasingly reluctant to hold $. Gradually, the US stock of gold was depleted. The Fund was the source of financing for a member country experiencing a temporary disequilibrium in its balance of payments. These resources come from gold and currency subscriptions of its members.
  • 42. Reserve/Gold tranche / Credit tranche Upon entering the Fund, each country was allotted a quota in accordance with its relative economic size. Reserve (gold) tranche: 25% of quota was paid to the Fund in gold (1944 US dollar). Today, this must be paid in SDR or major currencies ($, £, € and yen). Credit tranche: 75% of quota was paid in the currency's own currency.
  • 43. Quota In 1946, the Fund started with aggregate quotas of $8 billion, 20% of world reserves. (Today, this amount is worth roughly $100 billion) The quota was raised in 1971. The largest quota was US: $6.7 billion (21.9%): U.K. $2.8 billion (9.2%), Germany, France 5%, Japan 4%. The quota was increased several times. In 1990 the quota was increased to $135 billion, still equal to about 20% of world reserves. In 2011, quota increased to SDR 477 billion (about $677 billion). There have been no increases thereafter.
  • 44. Quota The quota determines the voting power of a member's executive director. (250 votes + 1 vote for SDR100,000) e.g., US = 17.75% ($65 billion), total = $366 billion (as of 2009) Total: 2.5 million votes (and growing). US holding of gold: currently, about 8,000 tons ($160 billion at $40 per oz), or about 5% of the world's total gold stock. (the world has about 190,000 tons in 2019, World Gold Council) Jewelry: 90,000 tons, Investors: 40,000 tons, governments: 33,000 tons
  • 45. Borrowing The size of a country's quota determines the borrowing limit of that country. (i) Basic Facility: gold tranche + 4 credit tranche = 125% (ii) Extended Facility: 140% (iii) Standby Agreements: Short term borrowing member countries negotiate to receive the Fund's guarantee. usually borrowing is for 3-5 years. .
  • 46. Borrowing (iv) General Agreements to Borrow (GAB): was negotiated in 1962 by the Group of Ten: France, Italy, Germany, Belgium, Netherlands, Sweden, Japan, UK, US, Canada. Switzerland joined in 1964. The fund could borrow up to $5.9 billion from the Group of Ten to provide more short term assistance. (v) Currency Swap Arrangements : made in 1962. bilateral arrangements between central banks. Purpose: to avoid exchange control. At maturity, both parties re-exchange the original amounts. The total quota is small, not sufficient to deal with the European crisis. In 2008, Japan lent $100 billion to the IMF. US also extended $100 billion line of credit.
  • 47. SPECIAL DRAWING RIGHTS Benefits of Reserve Currency (i) avoid exchange rate risk: (a) Exchange rates between two currencies can be volatile, dramatically changing the prices of the goods. (b) Traders are reluctant to use the currencies of small countries. (ii) Other countries hold dollar balances for transactions purposes ⇒They are lending money to the US (interest-free loans, much like the commercial banks paying no interest to checking account balances). US firms have easier access to the financial market. US has unlimited financing (Douglas North, 1993 Nobel lecture)
  • 48. Benefits of Reserve Currency In particular, President of France, De Gaulle, complained in 1965 that the US enjoys the hegemony, using "worthless paper to plunder other nation's resources and factories." (unlimited financing) Vladimir Putin: "US is a parasite on the world economy." (Reuters, Aug 1, 2011). The Russia- China currency swap has been ineffective due to low demand for the Ruble.
  • 49. Costs US did not coerce any country to hold USD. USD has been simply more reliable, and trading countries were willing to hold USD. As the demand for the reserve currency increases, and USD appreciates. ⇒ US trade deficit increases. In a certain sense, SDR allocations were like the credit limits on a person's credit card or line of credit. SDRs can be used to make payments to settle debts between central banks. In addition, each member country agreed to accept three times its own SDR quota from other central banks.
  • 50. An agreement was reached at the IMF annual meeting in Rio de Janeiro in 1967 to issue SDRs to be allocated to 104 participants. The first allocation was made in 1970 (3.4 billion), then 1971 (2.95 billion), 1972 (2.95 billion)
  • 51. value of SDR Originally, the value of an SDR was set at one US dollar, both having the same weight in gold in 1970. However, dollar was devalued a couple of times, and there was a general move to end the key role of $ in the international monetary system. After July 1, 1974, the value of SDR was determined in terms of "basket" of 16 main currencies. Weights: USD = 33%, mark = 12.5%, pound = 9%, FF = 7.5%, yen = 7.5%, CND = 6%, lira = 6%. From April 1980, only 5 major currencies. $ = 42%, DM = 19%, yen = 13%, FF = 13%, pound = 13% The value of SDR is calculated daily by IMF.
  • 52. SDR included $, euro, pound and yen. 1 SDR = $1.50 as of 2013 From October 1, 2016, five currencies are included: USD, €, Renminbi, yen, £ (GBP). Renminbi is not "freely convertible" in international transactions. Codes: USD, EUR, GBP, CNY, JPY, XDR SDRs are merely bookkeeping entries. It becomes a reserve asset because of the commitment of participating countries to accept SDRs up to an amount equal to 3 times their own SDR allocations.
  • 53. creation of SDR A decision to create SDRs require the approval of a majority of member countries holding 85% of the weighted voting power of the Fund. Once created, SDRs are distributed to participants in proportion to Fund quotas. As of 2009, the total allocation reached SDR 204 billion. Between central banks Unlike dollar and other currencies, SDRs are not usable for private international transactions.
  • 54. SDRs represent a net addition to international reserve that are as useful as gold or dollars, unlike international borrowing (which does not change reserves). Since it costs nothing to create SDRs, the world saves resources that would otherwise be wasted to mine and refine gold. For this reasons, SDRs are sometimes called paper gold. However, they should be called "e-Gold" (electronic gold) since no paper notes are issued.
  • 55. Importance SDR plays a limited role as an international reserve asset due to its small quantity relative to the daily transactions volume (about $5 trillion dollars) in the foreign exchange market. Its main function is the unit of account of transactions of international organizations and central banks. SDR is not tied to any single currency., and hence there is no need for the US to have large trade deficits in order to provide more reserves to the ROW.
  • 56. SDRs can be created as needed to insure stable growth of international reserves. If SDRs replace $ as reserve assets in central banks, the US does not have to be a world banker. SDR makes the IMF an international central bank.
  • 57. interest rate Once every year, the IMF charges every country interest on allotment, and credits every country with interest on the average SDR holdings during the past year. The interest rate was 1.5% per year originally, but raised to 5% in 1975. Now it is calculated weekly based on a weighted average of short term interest rates in the basket currencies (Euro, Yen, Pound Sterling, USD). 1 SDR is about $1.5 in April 2014.
  • 58. The Role of the US Dollar The international monetary system evolved in a way that was not foreseen in the Articles of Agreement of IMF. During the 1950s the USD increasingly took over the function of gold as the major international reserve asset. Why hold dollar, not gold? No one planned this development. The US was the dominant world power. (US share of output: 50% in 1950, 40% in 1960, but has been stable at 25% since the 1980s
  • 59. Well over half of all international money transactions were financed in terms of dollar The US also owned about two thirds of the official gold reserve in the world in 1940. The dollar became the dominant invoice currency. (The US profits as the banker.) Most exporters invoiced the importers in dollars. When the European countries had reserve surpluses in the 1950s and early 1960s, they converted the surpluses into dollar reserves rather than gold because. (i) interest could be earned on dollar assets, and (ii) dollar reserves can always be converted into gold at $35 per ounce whenever it became necessary.
  • 60. All of the non-Communist countries maintained a stable relationship between their currencies and the dollar either directly or indirectly through the British pound. The US dollar was at the center of this system. Since the Great Britain had halted the gold convertibility of its currency, US dollar was the only currency directly convertible into gold for official purposes. Before WWI, the pound sterling performed a similar function, but the sterling area had shrunken to a small number of countries. As the Bretton Woods system evolved, the reserves of most countries became a mixture of gold and dollars. Over time, US dollar became increasingly more important.
  • 61.
  • 62. dollar as principal reserve asset The US balance of payments was more important than those of other countries, because other countries were holding US dollar as the principal reserve asset. Moreover, the US was unable to eliminate ever-increasing trade deficits, which undermined the Bretton Woods system. External debts: US: $18 trillion EU: $14 UK: $7 Japan: $3
  • 63. Five Ways to Correct BP Deficits (1) deflate the economy use contractionary Monetary policy (raise interest rate) or Fiscal policy (cut federal spending) to reduce aggregate demand. This is a painful option because the government will become less popular. (e.g., Great Britain after WWI) A permanent but painful solution. (2) devalue As the price of the foreign currency (e) rises, net exports = X(e) - M(e) declines, which reduces trade deficit.
  • 64. Five Ways to Correct BP Deficits (3) impose exchange control on current account An exchange control limits imports. A temporary stopgap solution. (4) deplete gold stock A temporary remedy. Since the stock of gold is limited, it will soon run out.
  • 65. Five Ways to Correct BP Deficits (5) increase liabilities to foreign central banks. (6)The surplus country (e.g., China) holds more dollar assets. This means the US is unwilling to devalue $, or the surplus country (e.g., China) is unwilling to let RMB appreciate. A temporary solution, and eventually the latter country gives up. Instead of importing American goods, China buys dollar assets. As China holds more dollar assets, their value in RMB declines when RMB appreciates (Chinese investors lose money: buy high, sell low) China buys properties in the middle east, and central Asia (Kazakhstan) (Silkroad Economic Belt, 2013) China's trade/GDP ratio = 41% in 2015 US = 30%)
  • 66. US Payments Deficit in the 1960s Persistent US BP deficits in the 60s In the 1960s the international monetary system was shaken by a series of disturbances in the foreign exchange and gold markets. Since the US dollar was used as the principal reserve asset by our trading partners, the weakness of dollar raised doubts about the viability of the entire system.
  • 67. Persistent US BP deficits in the 60s During the period 1958-1971, the US experienced a persistent deficit in its balance of payments. At first, economists viewed these annual deficits as temporary. However, it gradually dawned to policy makers that the US deficits were not disappearing. The causes of these chronic deficits are: (a) a higher rate of return r* > r, which results in capital outflows. (b) military commitments in Europe and Asia. (c) The Vietnam war also caused inflation in the US.
  • 68. International reserve assets of the US During the years 1958-1971, the US experienced a cumulative reserve deficit of $56 billion. International reserve in other countries mainly consisted of US dollar and gold, although the currencies of other major countries were reserve assets but they played a minor role. US reserve assets included foreign currencies such as Yen, DM and British pound at first. However, by the end of the 1960s, the US international reserve consisted mainly of gold. Some of the fundamentals are wrong (p, w, r, Y, e). The first best policy is a devaluation of USD. All other policies such as lowering interest rates are second best.
  • 69. Increasing liabilities to foreign central banks During this period (from 1958 to 1971), the US not only witnessed a gradual depletion of its international reserve assets but also a dramatic increase in liabilities to foreign central banks. Gold Coverage of a currency = Gold held by the Fed/Liabilities to Foreign Central Banks
  • 70. Gold coverage in 1963 Gold coverage in 1971 (a few months after Nixon’s declaration of dollar’s gold inconvertibility)
  • 71. By 1963, the US gold reserve at FRB New York (Manhattan) barely covered liabilities to foreign central banks, and by 1970 the gold coverage had fallen to 55%, by 1971 22%. Thus, from 1963, had the foreign central banks tried to convert their dollar reserves into gold, the US would have been forced to abandon dollar's gold convertibility.
  • 72. Collapse of the Bretton Woods Temporary measures To lesson the outflow of private capital, the US imposed an interest equalization tax in 1963. This was effective to curb temporarily the outflow of portfolio investment. However, because r* > r, it was more than offset by a big jump in US bank loans to foreign borrowers and a further growth in US direct investment.
  • 73. (a) Voluntary Foreign Credit Restraint program was adopted in 1965 (Canada and developing countries were exempted). This was replaced by Mandatory Investment Controls in 1968, lifted in 1975. (b)Federal Reserve System entered into a series of currency swap agreements with central banks of Western Europe, Canada, and Japan. Under these bilateral agreements, a foreign central bank provided standby credit (in foreign currency) to the Federal Reserve System in return for an equal amount of standby credit (in dollar). None of these measures reduced US basic deficit but lessened the gold drain and dampened the speculative capital outflows. President Nixon once raised the value of dollar, to penalize the speculators. (It did not work).
  • 74. Collapse of Bretton Woods President Richard Nixon The crisis of 1971 was caused by a gradual loss of confidence in dollar. In 1970, funds began to move at an enormous rate from the US dollar to financial centers in Europe and Japan. In May 1971, West Germany left the Bretton woods system. Switzerland redeemed $50 million for gold. In early August 1971, France sent a battleship to New York harbor and took delivery of $191 million in gold (Huffington Post).
  • 75. Collapse of Bretton Woods Then on August 11, the British ambassador requested to redeem $3 billion for gold (1/3 of US gold reserve, Tyler Durden) President Nixon announced on August 15, 1971: (i) a 90-day freeze on wages and prices (ii)10% import surcharge on dutiable imports (iii) suspension of dollar's convertibility into gold.
  • 76. "Dollars for Oil" replaces "Dollars for gold” After the Yom Kippur war (October 6-25, 1973), in July 1974, Kissinger sent his deputy William Simon to the Middle East. Kissinger and Saudi royal family agreed: (i) All of oil sales will be prices in USD (Saudi's will not accept other currencies), and invest surplus oil revenues in US securities, (ii) in return, US will protect Saudi's oil fields and guarantee protection from Israel.
  • 77. SMITHSONIAN AGREEMENT International monetary negotiations were undertaken within the framework of the Group of Ten. Details were worked out by the Group of Ten in a meeting at the Smithsonian Institution in Washington DC in December 1971. The agreement was then formalized by the IMF. It was a temporary regime. The agreement allowed member countries to vary their exchange rates within margins of 2 ¼% on either side of the central rates after currency realignment.
  • 78. Currency realignment: Yen appreciated 17%, Mark 13.5 %, pound 9%, FF 9%. Par value of other minor currencies were also changed. In return for the revaluation of other currencies, the U.S. agreed to raise the price of gold from $35 to $38 an ounce. This was equivalent to a dollar devaluation of 8.57%. This devaluation of dollar has no significance because the dollar remains inconvertible. 10% import surcharge was suppressed. The collapse of the Bretton Woods system did not generate a chaos as did the collapse of the international gold standard in the 1930s.
  • 79. The Smithsonian Agreement was a useless attempt to perpetuate the adjustable peg system with a new currency alignment. Par Value Modification Act, 1973 (amended) With the second devaluation of the dollar in March 1973 by 11% (the price of gold rose from $38.00 to $42.22 per ounce), the Smithsonian agreement fell apart and other currencies were left to float against the dollar. Bank of Japan absorbed a few billion dollars in one week, but eventually quit.
  • 80.
  • 81. The International Monetary Fund (IMF) is an organization of 189 member countries, each of which has representation on the IMF's executive board in proportion to its financial importance, so that the most powerful countries in the global economy have the most voting power. Objective ―Foster global monetary cooperation ―Secure financial stability ―Facilitate international trade ―Promote high employment and sustainable economic growth ―And reduce poverty around the world
  • 82. History The IMF, also known as the Fund, was conceived at a UN conference in Bretton Woods, New Hampshire, United States, in July 1944. The 44 countries at that conference sought to build a framework for economic cooperation to avoid a repetition of the competitive devaluations that had contributed to the Great Depression of the 1930s. Countries were not eligible for membership in the International Bank for Reconstruction and Development (IBRD) unless they were members of the IMF.
  • 83. IMF, as per Bretton Woods agreement to encourage international financial cooperation, introduced a system of convertible currencies at fixed exchange rates, and replaced gold with the U.S. dollar (gold at $35 per ounce) for official reserve. After the Bretton Woods system (system of fixed exchange rates) collapsed in the 1971, the IMF has promoted the system of floating exchange rates. Countries are free to choose their exchange arrangement, meaning that market forces determine the value of currencies relative to one another. This system continues to be in place today.
  • 84. During 1973 oil crisis, IMF estimated that the foreign debts of 100 oil-importing developing countries increased by 150% between 1973 and 1977, complicated further by a worldwide shift to floating exchange rates. IMF administered a new lending program during 1974–1976 called the Oil Facility. Funded by oil-exporting nations and other lenders, it was available to nations suffering from acute problems with their balance of trade due to the rise in oil prices.
  • 85. IMF was one of the key organisations of the international economic system; its design allowed the system to balance the rebuilding of international capitalism with the maximisation of national economic sovereignty and human welfare, also known as embedded liberalism. The IMF played a central role in helping the countries of the former Soviet bloc transition from central planning to market-driven economies.
  • 86. In 1997, a wave of financial crises swept over East Asia, from Thailand to Indonesia to Korea and beyond. The International Monetary Fund created a series of bailouts (rescue packages) for the most-affected economies to enable them to avoid default, tying the packages to currency, banking and financial system reforms.
  • 87. Global Economic Crisis (2008): IMF undertook major initiatives to strengthen surveillance to respond to a more globalized and interconnected world. These initiatives included revamping the legal framework for surveillance to cover spill-overs (when economic policies in one country can affect others), deepening analysis of risks and financial systems, stepping up assessments of members’ external positions, and responding more promptly to concerns of the members.
  • 88. Functions Provides Financial Assistance: To provide financial assistance to member countries with balance of payments problems, the IMF lends money to replenish international reserves, stabilize currencies and strengthen conditions for economic growth. Countries must embark on structural adjustment policies monitored by the IMF.
  • 89. Functions IMF Surveillance: It oversees the international monetary system and monitors the economic and financial policies of its 189 member countries. As part of this process, which takes place both at the global level and in individual countries, the IMF highlights possible risks to stability and advises on needed policy adjustments.
  • 90. Functions Capacity Development: It provides technical assistance and training to central banks, finance ministries, tax authorities, and other economic institutions. This helps countries raise public revenues, modernize banking systems, develop strong legal frameworks, improve governance, and enhance the reporting of macroeconomic and financial data. It also helps countries to make progress towards the Sustainable Development Goals (SDGs).
  • 91. IMF Reforms IMF Quota: a member can borrow up to 200 percent of its quota annually and 600 percent cumulatively. However, access may be higher in exceptional circumstances. IMF quota simply means more voting rights and borrowing permissions under IMF. But it is unfortunate that IMF Quota’s formula is designed in such a way that USA itself has 17.7% quota which is higher than cumulative of several countries. The G7 group contains more than 40% quota where as countries like India & Russia have only 2.5% quota in IMF.
  • 92. Due to discontent with IMF, BRICS countries established a new organization called BRICS bank to reduce the dominance of IMF or World Bank and to consolidate their position in the world as BRICS countries accounts for 1/5th of WORLD GDP and 2/5th of world population. It is almost impossible to make any reform in the current quota system as more than 85% of total votes are required to make it happen. The 85% votes does not cover 85% countries but countries which have 85% of voting power and only USA has voting share of around 17% which makes it impossible to reform quota without consent of developed countries.
  • 93. 2010 Quota Reforms approved by Board of Governors were implemented in 2016 with delay because of reluctance from US Congress as it was affecting its share. Combined quotas (or the capital that the countries contribute) of the IMF increased to a combined SDR 477 billion (about $659 billion) from about SDR 238.5 billion (about $329 billion). It increased 6% quota share for developing countries and reduced same share of developed or over represented countries.
  • 94. More representative Executive Board: 2010 reforms also included an amendment to the Articles of Agreement established an all-elected Executive Board, which facilitates a move to a more representative Executive Board. The 15th General Quota Review provides an opportunity to assess the appropriate size and composition of the Fund’s resources and to continue the process of governance reforms.
  • 95. • One proposed reform is a movement towards close partnership with other specialist agencies such as UNICEF, the Food and Agriculture Organization (FAO), and the United Nations Development Program (UNDP). • IMF loan conditions should be paired with other reforms—e.g., trade reform in developed nations, debt cancellation, and increased financial assistance for investments in basic infrastructure.
  • 96. • COVID-19 Financial Assistance and Debt Service Relief • The IMF is providing financial assistance and debt service relief to member countries facing the economic impact of the COVID-19 pandemic. overview of assistance approved by the IMF’s Executive Board since late March 2020 under its various lending facilities and debt service relief financed by the Catastrophe Containment and Relief Trust (CCRT). Overall, the IMF is currently making about $250 billion, a quarter of its $1 trillion lending capacity, available to member countries.
  • 97. As part of the COVID19-related rapid arrangements, borrowing countries have committed to undertake governance measures to promote accountable and transparent use of these resources. Total Debt Relief for 29 Countries: 1st Tranche: SDR 183.13 million / US$ 251.24 million 2nd Tranche: SDR 168.40 million / US$ 237.46 million 3rd Tranche: SDR 168.07 million / US$ 238.05 million Debt service relief total: SDR 519.60 million / US$ 726.75 million https://www.imf.org/en/Topics/imf-and- covid19/COVID-Lending-Tracker#APD Total Financial Assistance for 85 Countries: SDR 81,715.40 million / US$ 113,067.08 million
  • 98. The Executive Board of the International Monetary Fund (IMF) today approved a disbursement to the Central Bank of Solomon Islands for an amount of SDR 20.8 million (about US$28.5 million, 100 percent of quota), comprising SDR 6.93 million (about US$ 9.5 million, 33.3 percent of quota) under the Rapid Credit Facility (RCF) and SDR 13.87 million (about US$ 19 million, 66.7 percent of quota) under the Rapid Financing Instrument (RFI) to help cover urgent balance of payments needs stemming from the COVID-19 pandemic.
  • 99. The Rapid Financing Instrument (RFI) provides rapid financial assistance, which is available to all member countries facing an urgent balance of payments need. The RFI was created as part of a broader reform to make the IMF’s financial support more flexible to address the diverse needs of member countries. The RFI replaced the IMF’s previous emergency assistance policy and can be used in a wide range of circumstances.
  • 100. The Rapid Credit Facility (RCF) provides rapid concessional financial assistance with limited conditionality to low-income countries (LICs) facing an urgent balance of payments need. The RCF was created under the Poverty Reduction and Growth Trust (PRGT) as part of a broader reform to make the Fund’s financial support more flexible and better tailored to the diverse needs of LICs, including in times of crisis. The RCF places emphasis on the country’s poverty reduction and growth objectives. Financing under the RCF carries a zero interest rate, has a grace period of 5½ years, and a final maturity of 10 years.
  • 101. IMF and India International regulation by IMF in the field of money has certainly contributed towards expansion of international trade. India has, to that extent, benefitted from these fruitful results. Post-partition period, India had serious balance of payments deficits, particularly with the dollar and other hard currency countries. It was the IMF that came to her rescue.
  • 102. The Fund granted India loans to meet the financial difficulties arising out of the Indo–Pak conflict of 1965 and 1971. From the inception of IMF up to March 31, 1971, India purchased foreign currencies of the value of Rs. 817.5 crores from the IMF, and the same have been fully repaid. Since 1970, the assistance that India, as other member countries of the IMF, can obtain from it has been increased through the setting up of the Special Drawing Rights (SDRs created in 1969).
  • 103. India had to borrow from the Fund in the wake of the steep rise in the prices of its imports, food, fuel and fertilizers. In 1981, India was given a massive loan of about Rs. 5,000 crores to overcome foreign exchange crisis resulting from persistent deficit in balance of payments on current account. India has availed of the services of specialists of the IMF for the purpose of assessing the state of the Indian economy. In this way India has had the benefit of independent scrutiny and advice. The balance of payments position of India having gone utterly out of gear on account of the oil price escalation since October 1973, the IMF has started making available oil facility by setting up a special fund for the purpose.
  • 104. India wanted large foreign capital for her various river projects, land reclamation schemes and for the development of communications. Since private foreign capital was not forthcoming, the only practicable method of obtaining the necessary capital was to borrow from the International Bank for Reconstruction and Development (i.e. World Bank).
  • 105. Early 1990s when foreign exchange reserves – for two weeks’ imports as against the generally accepted 'safe minimum reserves' of three month equivalent — position were terribly unsatisfactory. Government of India's immediate response was to secure an emergency loan of $2.2 billion from the International Monetary Fund by pledging 67 tons of India's gold reserves as collateral security. India promised IMF to launch several structural reforms (like devaluation of Indian currency, reduction in budgetary and fiscal deficit, cut in government expenditure and subsidy, import liberalisation, industrial policy reforms, trade policy reforms, banking reforms, financial sector reforms, privatization of public sector enterprises, etc.) in the coming years.
  • 106. • The foreign reserves started picking up with the onset of the liberalisation policies. • India has occupied a special place in the Board of Directors of the Fund. Thus, India had played a creditable role in determining the policies of the Fund. This has increased the India’s prestige in the international circles.
  • 107.
  • 108. Evaluations of International Monetary System Gold Standard: Gold has historically been used as a medium of exchange primarily due to its scarce availability and desirable properties. Besides its durability, portability, and ease of standardization, the high production costs of the yellow metal make it costly for governments to manipulate short-run changes in its stock. As gold is commodity money, it tends to promote price stability in the long run. Thus, the purchase power of an ounce of gold will tend toward equality with its long-run cost of production.
  • 109. The various versions of gold standards used were: Gold specie standard: The actual currency in circulation consists of gold coins with fixed gold content. Gold bullion standard: The currency in circulation consists of paper notes but a fixed weight of gold remains the basis of money. Any amount of paper currency can be converted into gold and vice versa by the country’s monitory authority at a fixed conversion ratio.
  • 110. Gold exchange standard: Paper currency can be converted at a fixed rate into the paper currency of the other country, if it is operating a gold specie or gold bullion standard. Such an exchange regime was followed in the post- Bretton Woods era. Exchange rates from 1876 to 1913 were generally dictated by gold standards. Each country backed up its currency with gold, and currencies were convertible into gold at specified rates. Relative convertibility rates of the currencies per ounce of gold determined the exchange rates between the two currencies.
  • 111. Gold standard was suspended following World War I in 1914 and governments financed massive military expenditure by printing money. This led to a sharp rise both in the supply of money and market prices. Hyperinflation in Germany presents a classic example where the price index rapidly shot from 262 in 1919 to 12,61,60,00,00,00,000 (a factor of 481.5 billion) in December 1923. The US and some other countries returned to gold standards so as to achieve financial stability, but following the Great Depression in 1930, gold standards were finally abandoned. Some countries attempted to peg their currencies to the US dollar or British pound in the 1930s but there were frequent revisions. This followed severe restrictions on international transactions and instability in the foreign exchange market, leading to a decline in the volume of international trade during this period.
  • 112. Fixed Exchange Rates: In July 1944, representatives of 44 allied nations agreed to a fixed rate monetary system and setting up of the International Monetary Fund in a conference held in Bretton Woods, New Hampshire. Each member country pledged to maintain a fixed or pegged exchange rate for its currency vis-a-vis gold or the US dollar. Since the price of each currency was fixed in terms of gold, their values with respect to each other were also fixed. For instance, price of one ounce of gold was fixed equal to US$35. This exchange regime, following the Bretton Woods Conference, was characterized as the Gold Exchange Standard.
  • 113. In the Bretton Woods era, which lasted from 1944 to 1971, fixed exchange rates were maintained by government intervention in the foreign exchange markets so that the exchange rates did not drift beyond 1 per cent of their initially established levels. Under the Bretton Woods system, the US dollar effectively became the international currency. Other countries accumulated and held US dollars for making international payments whereas the US could pay internationally in its own currency.
  • 114. By 1971, the foreign demand for the US dollar was substantially less than the supply and it appeared to be overvalued. On 15 August 1971 the US government abandoned its commitment to convert the US dollar into gold at the fixed price of US$35 per ounce and the major currencies went on a float.
  • 115. In an attempt to revamp the monetary system, consequent to a conference of various countries’ representatives, the Smithsonian Agreement was concluded in December 1971, which called for a devaluation of US dollar by 8 per cent against other currencies and pegging the official price of gold to US$38 per ounce. Besides, 2.25 per cent fluctuations in either direction were also allowed in the newly set exchange rates.
  • 116. Pros and cons of fixed exchange rate system: Under the fixed exchange rate system, international managers can operate their international trade and business activities without worrying about future rates. However, companies do face repercussions of currency devaluation both by their home and the host countries. Further, the currency of each country becomes more vulnerable to economic upheavals in other countries.
  • 117. Floating Exchange Rate System: Even after the Smithsonian Agreement, governments still faced difficulty in maintaining their exchange rates within the newly established exchange rates regime. By March 1973, the fixed exchange rate system was abandoned and the world officially moved to a system of floating exchange rates. Under the freely floating exchange rate system, currency prices are determined by market demand and supply conditions without the intervention of the governments.
  • 118. Pros and cons of floating exchange rates: A country under the floating exchange rate system is more insulated from inflation, unemployment, and economic upheavals prevalent in other countries. Thus, the problems faced in one country need not be contagious to another. The adjustment of exchange rates serves as a form of protection against exporting economic problems to other countries. Besides, the central bank of a country is not required to constantly maintain the exchange rates within the specified limits and to make frequent interventions.
  • 119. Although other countries are reasonably insulated from the problems faced by one country under the freely floating exchange rates, the exchange rates themselves can further aggravate the economic woes of a country plagued by economic problems and unemployment. This possibility makes it essential for international managers to devote substantial resources to measure and manage the exposure to exchange rate fluctuations.
  • 120. Special Drawing Rights (SDR) Special drawing rights (SDRs) are supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund (IMF) SDR is not a currency, instead represents a claim to currency held by IMF member countries for which they may be exchanged. The value of an SDR is defined by a weighted currency basket of four major currencies: the US dollar, the euro, the British pound, the Chinese Yuan and the Japanese yen Central bank of member countries held SDR with IMF which can be used by them to access funds from IMF in case of financial crises in their domestic market
  • 121.
  • 122. Controversy over Regulation of International Finance As the global market expands, the need for international regulation becomes urgent. Since World War II, financial crises have been the result of macroeconomic instability until the fatidic week end of September 15 2008, when Lehman Brothers filed for bankruptcy. The financial system had become the source of its own instability through a combination of greed, lousy underwriting, fake ratings and regulatory negligence.
  • 123. Controversy over Regulation of International Finance From that date, governments tried to put together a new regulatory framework that would avoid using taxpayer money for bailout of banks. In an uncoordinated effort, they produced a series of vertical regulations that are disconnected from one another. That will not be sufficient to stop finance from being instable and the need for international and horizontal regulation is urgent.
  • 124.
  • 125. Developing Countries' Concerns, in three areas where further change is certainly needed: -First, the international financial architecture, where important reforms have been made, but where the hard work of implementation still lies ahead; -Second, in international financial regulation, where there is more work to do to ensure that the right incentives are in place for financial institutions in developed and developing markets to manage their risks more effectively in future; and -
  • 126. Developing Countries' Concerns, Third, in emerging market countries themselves, where there is a need for more practical efforts to upgrade accounting and legal standards, and systems of financial regulation, and of course to clean up the balance sheets of banking systems which, in many cases, remain very fragile.
  • 127. The main elements of that quiet revolution are: - much more outreach for banking supervisors, above all to supervisors in emerging markets; - increasing acceptance by all supervisors that core principles of supervision, rigorously applied in all countries of the world, are essential; - increasing acceptance of the need for external monitoring to ensure compliance with those core principles;
  • 128. - a willingness by supervisors to work much more closely than before with the financial institutions as the leaders of that monitoring exercise; - greater willingness by supervisors to work more closely with each other across borders and across traditional sectors of banking, securities and insurance;
  • 129. -a willingness by the Fund and the Bank to take on the rôle of monitoring and to integrate financial sector surveillance and reconstruction much more closely into their work; and -a desire by the international financial community to consider more carefully the threats to financial stability, to put in place better incentives for avoiding such crises, and to bring together the key government officials, supervisors, central banks and the financial institutions, through the new Financial Stability Forum.
  • 130.
  • 131. Exchange Rate Policy of Developing Economies. An exchange rate, as a price of one country's money in terms of another's, is among the most important prices in an open economy. It influences the flow of goods, services, and capital in a country, and exerts strong pressure on the balance of payments, inflation and other macroeconomic variables. Therefore, the choice and management of an exchange rate regime is a critical aspect of economic management to safeguard competitiveness, macro economic stability, and growth
  • 132. Exchange Rate Policy of Developing Economies. The choice of an appropriate exchange rate regime for developing countries has been at the center of the debate in international finance for a long time. ―What are the costs and benefits of various exchange rate regimes? ―What are the determinants of the choice of an exchange rate regime and how would country circumstances affect the choice? ― Does macroeconomic performance differ under alternative regimes? ―How would an exchange rate adjustment affect trade flows?
  • 133. The steady increase in magnitude and variability of international capital flows has intensified the debate in the past few years as each of the major currency crises in the 1990s has in some way involved a fixed exchange rate and sudden reversal of capital inflows. New questions include: ―Are pegged regimes inherently crisis-prone? ― Which regimes would be better suited to deal with increasingly global and unstable capital markets?
  • 134. While today almost every advanced nation has a flexible exchange rate regime similar to that advocated by Milton Friedman, most emerging countries continue to have ‘conventional peg’. Historical work of Milton Friedman examined the conditions under which he thought that flexible rates were the right system for developing countries, and when he thought that it was appropriate to have an alternative regime.
  • 135. The currency crises in Lebanon, Turkey, and Argentina have once again brought to the fore the question of the optimal exchange rate regime in an emerging country. Almost 70 years ago, Milton Friedman published “The case for flexible exchange rates” (Friedman 1953). In it he argued that a system of ‘pegged but adjustable’ parities was highly unstable and made a strong pitch for flexible exchange rates regimes.
  • 136. While today almost every advanced nation has a flexible exchange rate regime similar to the one advocated by Friedman, most emerging countries continue to have ‘conventional peg’ (IMF 2019). What Friedman’s views on currency and monetary regimes in developing countries were. In a 1973 Congressional testimony, Friedman said: “[w]hile I have long been in favor of a system of floating exchange rates for the major countries, I have never argued that that is necessarily also the best system for the developing countries.”
  • 137. Milton Friedman in India: 1955 and 1963 In 1955, Milton Friedman traveled to India to advise the Nehru government. He prepared a short memorandum that covered, among other things, the exchange rate issue. At the time, foreign exchange was rationed and allocated in a discretionary fashion. Friedman wrote that there were only two ways to deal with external imbalances: “First, to inflate or deflate internally in response to a putative surplus or deficit in the balance of payments;
  • 138. Milton Friedman in India: 1955 and 1963 second, to permit the exchange rate to fluctuate… [a method] that has been adopted by Canada with such conspicuous success” (Friedman 1955). He added that if a completely free float was ruled out (for political reasons), an auction system was a solid second-best solution. This would allow “purchasers to use it for anything they wish and in any currency area they wish.”
  • 139. Friedman returned to India in 1965. This time he was particularly critical of the Bretton Woods’ pegged-but-adjustable regime. A mere devaluation, he stated, was not a solution in a country with chronic inflation. In a lecture delivered in Mumbai he said: “The temptation will be to change its [the rupee’s] value from its present level… and then try to hold it at the new fixed level. That would be another mistake. Even if the new exchange rates are correct when established, once you pegged them, there is no assurance that they will indefinitely remain correct” (Friedman 1968).
  • 140. The ten regimes are arranged under the following four relatively homogeneous groups (a) Floating regimes (independent floating, lightly managed float); (b) Intermediate regimes (managed float, crawling broad band); (c) Soft peg reglmes (crawling narrow band, crawling peg, pegged within bands, fixed peg); and (d) Hard peg regimes (currency board, currency union/dollarization).
  • 141.
  • 142.
  • 143.
  • 144.
  • 145. The floating regimes would be an appropriate choice for medium and large industrialized countries and some emerging market economies that have import and export sectors that are relatively small compared to GDP, but are fully integrated in the global capital markets and have diversified production and trade, a deep and broad financial sector, and strong prudential standards. The hard peg regimes are more appropriate for countries satisfying the optimum currency area criteria (countries in the European Economic and Monetary Union), small countries already integrated in a larger neighboring country (dollarization in Panama), or countries with a history of monetary disorder, high inflation, and low credibility of policymakers to maintain stability that need a strong anchor for monetary stabilization (currency board in Argentina and Bulgaria).
  • 146. The soft peg regimes would be best for countries with limited links to international capital markets, less diversified production and exports, and shallow financial markets, as well as countries stabilizing from high and protracted inflation under an exchange rate-based stabilization program (Turkey). These are largely but not exclusively non emerging market developing countries . The intermediate regimes, a middle road between floating rates and soft pegs, aim to incorporate the benefits of floating and pegged regimes while avoiding their shortcomings.
  • 147.
  • 148. The macroeconomic authorities of developing and transition countries are faced with a difficult task. On the one hand, the global economy is unstable with frequent shocks, crises and volatilities. It is also a place with fierce competition with multinational corporations of EU, US, Japan and Korea, the emergence of China as the factory of the world, dumping and unfair trade practices by some exporters, etc. On the other hand, the domestic capability of most developing and transition countries is still weak. The market economy is not well developed, and domestic enterprises lack competitiveness. The government is often saddled with inefficiency, corruption, lack of expertise, and political pressure.
  • 149. The question for the central bank governor and the finance minister is: how do you manage monetary policy, and especially the exchange rate, in order to avoid unnecessary shocks and provide stable environment for economic development? More specifically, in this age of accelerated globalization, what is the appropriate exchange rate system for developing or transition countries? The question is difficult enough, but to make the matter even more complicated, there are many policy goals but only one exchange rate.
  • 150. If a country has the multiple exchange rate system, the IMF will not seriously deal with you and FDI will probably not come. It is a good idea to unify the rates as soon as possible. China unified their rates in 1994 and Vietnam did so in 1989. Unification did not give them any big shock, and they began to receive large amounts of FDI after that, partly because of the improved exchange rate system.
  • 151. The government is often concerned about the social consequences of currency reunification, but people are usually much better off with a unified rate than without. The persistence of the multiple exchange rate practice is mainly a political problem, not economic. It is a huge and hidden subsidy and taxation system, from which some people benefit greatly.
  • 152. The possible goals for exchange rate management may include the following: 1. Competitiveness 2. Price stability 3. Current account adjustment 4. Domestic financial stability (protection of balance sheets of banks and firms) 5. Public debt management 6. Avoiding speculative attacks 7. Minimizing domestic impact of a large exogenous shock (like a regional conflict or currency crisis) 8. Promoting FDI, growth, or industrialization
  • 153. The first two goals--competitiveness and price stability--are very fundamental and all countries should mind them. The big problem is that these two goals often conflict with each other. To maintain competitiveness (or regain it after domestic inflation), the exchange rate should be flexible and devaluation must be accepted, if necessary.
  • 154. On the other hand, to contain domestic inflation or avoid imported inflation, the exchange rate should be either stable or even moderately overvalued (this is called the use of the exchange rate as a nominal anchor). But clearly, these two requirements are not compatible. it keeps the exchange rate stable, it will exert a deflationary pressure on the domestic economy so the inflation- devaluation spiral can be avoided. But in this case, competitiveness is lost due to overvaluation, and a recession is likely.
  • 155. The third goal--current account adjustment--is popular but controversial. Traditionally, devaluation is recommended to a country with a current account (or trade) deficit. However, whether it really works to reduce the deficit or not must be carefully studied in the context of each individual country. Devaluation is a double-edged sword; as noted above, it may trigger an inflation spiral. It may also affect the macroeconomy in other complicated ways to offset the intended relative-price effect
  • 156. The fourth and fifth goals--protecting the balance sheets of the private and public sectors--are related to the question of exchange exposure and losses. If the currency is devalued, the value of foreign currency-denominated debt will increase in home currency, which creates enormous difficulties for both the private and public sectors. Part of this debt can be hedged, but not all
  • 157. The sixth goal--avoiding speculative attacks--can be achieved by calming the market expectation. How can we do this? Some economists argue that the exchange rate should float. Exchange rate flexibility will remind traders that the currency can go both up as well as down, which discourages them from betting on exchange rate stability or one-way movement. This makes attacks less likely. But exchange rate volatility itself may become a problem. Perhaps the best way to avoid attacks is to avoid overvaluation, and that is attained by frequent reviews and proper adjustments of the exchange rate levels (i.e., fulfilling the competitiveness concern).
  • 158. The seventh goal--minimizing impact of a large external crisis--essentially is the question of the timing and manner of floating. If the currency of an important neighboring country collapses, your currency becomes suddenly overvalued, relatively speaking. The government must decide whether the home currency should (partly) follow this depreciation or remain stable. There is no easy rule of thumb as to whether you should float earlier, later, or not at all; it depends on individual cases.
  • 159. The eighth goal--promoting FDI, growth, or industrialization--is, in my view, a red herring. Such long-term real-sector development goals cannot be pursued by exchange rate management. The only thing that the central bank can do for this purpose is to maintain competitiveness and price stability (namely, doing well in the first two goals).
  • 160. Managed float After the Mexican (1994) and the Asian (1997) crises, many economists began to argue that dollar peg was dangerous. They contend that exchange rates should be flexible enough so adjustments are not delayed until too late. Some even argue that IMF should not lend to countries with a dollar peg !
  • 161. Bipolar view Some economists--Barry Eichengreen, Stanley Fischer and others--went even further. According to them, the reality of the 21st century with massive financial flows would not allow any country to adopt a "middle" solution such as target zones, adjustable peg, baskets, crawling peg, etc. They recommend that all countries, including developing and transition ones, to converge on either complete fix or 100% free floating.
  • 162. Currency board The currency board is an institutional arrangement to tie money supply closely to the amount of international reserves, so the monetary authority has no power to issue money independently (in principle, at least). In the most rigid case, monetary base can be issued or withdrawn only in exchange with foreign assets sold or bought against the monetary authority (however, most currency boards are not so rigid; there are loopholes and lee ways). With a currency board, monetary policy is not needed so the central bank is abolished and a simpler "monetary authority" takes over.
  • 163. Dollarization dollarization has two meanings. Private (or inadvertent) dollarization: people use dollars because they do not trust domestic money or foreign money is more convenient than domestic money. Official dollarization: the government declares USD to be the only official money for the country, and abolishes domestic money.
  • 164. Multiple currency basket (proposed for East Asia) multiple currency baskets consisting of dollar, yen and euro are recommended by some economists to the developing countries in East Asia. These baskets are supposed to automatically smooth the competitiveness shocks arising from the movements of major currencies (but they do not automatically adjust for other shocks
  • 165. Soft dollar zone (for East Asia) Ronald McKinnon argues that neither floating nor the currency basket is practical in East Asia. He notes that East Asian currencies actually returned to the soft dollar peg after the Asian crisis, the situation which he thinks is desirable and reasonable. The dollar is the key currency in the world economy and monetary stability should be built around it.
  • 166. Virtual exchange rate stability This is also proposed by Prof. McKinnon (especially for major countries). There should be a long-term, unchanging nominal exchange rate target based on tradable PPP (for example, $1=110 yen). The two countries (for example, Japan and the US) have the obligation to keep the rate within the narrow band around this target forever. When a large shock hits occasionally (once in a decade?), the rate can deviate temporarily from the target. But after the shock is gone, the rate must return to the original, unchanged band.
  • 167. Double target zones John Williamson (Institute of International Economics, Washington DC) is the champion of target zone proposals. He has many ideas, and the double target zone is one of them. There should be a "soft" inner band and a "hard" outer band, so the central bank will have three zones where (i) it does not intervene; (ii) it can intervene; and (iii) it must intervene.
  • 168. Band-basket-crawl (BBC) This idea, advanced by Rudiger Dornbusch and Y. C. Park, is a variation of the target zone proposal. The central rate should be defined by a multiple currency basket and there should be a band around it. Moreover, there is a built-in inflation sliding of the central rate. This is what I would call a currency basket with inflation slide.
  • 169. "Eclectic" view Jeffrey Frankel wrote a paper entitled: "No single currency regime is right for all countries or at all times." The right choice depends on circumstances, and each country should adopt the most suitable system for itself. The attempt to find a one- size-fits-all solution is misguided.