History of the International Monetary System, The IMF and World Bank, and Fixed vs. Flexible Exchang

1
Chapter 7

• History of the International Monetary System, The
  IMF and World Bank, and Fixed vs. Flexible
  Exchange Rates

2
History of the International Monetary System

• What is the international monetary system?
• Establishes the rules by which countries value
  and exchange their currencies
• Gold Standard (1821-1931)
• Countries would agree to buy or sell their
  currencies in exchange for gold
• Each countrys currency had a specific par value
• Created a fixed exchange rate system, since each
  county tied the value of its currency to gold
• Gold standard was interupted during WWI, but then
  maintained until 1931 when the Bank of England
  allowed the pound to float

3
History of the International Monetary System

• The Bretton Woods Era
• After the collapse of the gold standard, many
  countries attempted devaluations of their
  currencies
• Why?
• How?
• Countries also developed restrictive trade
  policies
• High tariffs on imports, import quotas
• As a result, international trade contracted
  greatly

4
History of the International Monetary System

• Bretton Woods (cont.)
• Because of the breakdown of international trade
  and because of the close of WWII, representatives
  of the worlds industr. countries met in Bretton
  Woods, NH in 1944
• Goal establish a stable monetary env. to facil.
  world trade
• Modified gold standard Dollar Based gold std.
• Also set up the IMF and the World Bank

5
Bretton Woods - details

• A change in exchange rates was only permitted in
  the case of a fundamental disequilibrium of a
  nations BOP
• But fundamental disequilibrium was never
  defined
• Came to mean a chronic BOP deficit
• Nations running BOP deficits would eventually
  devalue their currencies relative to the dollar

6
Bretton Woods - details

• Problems
• Since devaluations were only allowed after a long
  run of BOP deficits, they could be predicted by
  speculators and were large
• This didnt really lead to a stable climate for
  world trade
• Currencies would remain constant for long periods
  and then change drastically, rather than gradual
  changes
• Since the U.S. defined the value of gold, the
  U.S. could not devalue its currency
• U.S. ran persistent BOP deficits in the 1960s
• U.S. started running out of reserves to finance
  BOP deficits and the system collapsed in 1971
• Exchange rates have been under a dirty or managed
  float since 1973

7
Details of the IMF and World Bank

• Both created by Bretton Woods
• IMF
• Set up to police and manage international
  monetary system
• Countries join the IMF by paying a quota
• Gives voting power in the IMF
• Allows borrowing from the IMF (25 of quota)
• Counts as official reserves of a country
• Addl. Borrowing in exchange for agreeing to
  change economic policies reduce import
  barriers, less govt. involvement in economy

8
Details of the IMF and World Bank

• World Bank
• International Bank for Reconstruction and
  Development
• Owned by 184 member countries
• Originally formed to finance reconstruction of
  Europe from WWII
• Now to build the economies of developing
  countries
• Provides loans aimed at stimulating economic
  growth often infrastructure like highways
• Hard loan policy
• Reasonable expectation that the loan will be
  repaid

9
Details of the IMF and World Bank

• Three other organizations within the World Bank
• International Development Assoc. (IDA)
• Soft loans signif. risk of no repayment
• Interest free loans
• Focus on least developed countries
• International Finance Corp (IFC)
• Debt and equity financing for promising private
  sector activities in developing countries
• Multilateral Investment Guarantee Agency (MIGA)
• Insurance for private investors in developing
  countries for noncommercial risks politicial
  risk
• Regional Development Banks
• Focus on specific regions

10
Exchange Rates Fixed or Flexible?

• Advantage of fixed exchange rates
• Reduced risk to foreign trade
• Businesses importing goods may experience higher
  prices in the future deprec. of domestic
  currency
• Businesses exporting goods will experience a
  similar risk concerned with apprec. of domestic
  currency
• Uncertainty regarding exchange rates could
  inhibit trade
• Qualifier to this advantage exchange rates were
  really not very stable under Bretton Woods

11
Exchange Rates Fixed or Flexible?

• Disadvantage of fixed exchange rates
• LACK OF CONTROL OVER DOMESTIC ECONOMY
• BOP deficits or surpluses adjust with S and D
  rather than exchange rates
• Explain under gold standard
• Explain under Bretton Woods