Transcript International Monetary System - Southern Methodist University

International Monetary System
• ALTERNATIVE EXCHANGE RATE SYSTEMS
• A BRIEF HISTORY OF THE INTERNATIONAL
MONETARY SYSTEM
• THE EUROPEAN MONETARY SYSTEM
• Costs and benefits of a single currency
Alternative Exchange Rate Systems (Obvious but
important point)
• People trade currencies for two primary reasons
– To buy and sell goods and services
– To buy and sell financial assets
There are an enormous number of exchange rate
systems, but generally they can be sorted into one of
these categories
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Freely Floating
Managed Float
Target Zone
Fixed Rate
Important Note:
• Even though we may call it “free float” in fact the government
can still control the exchange rate by manipulating the factors
that affect the exchange rate (i.e., monetary policy)
Under a floating rate system, exchange rates are set
by demand and supply.
• price levels
• interest rates
• economic growth
Alternate exchange rate systems: Managed Float
(“Dirty Float”)
• Market forces set rates unless excess volatility occurs, then,
central bank determines rate by buying or selling currency.
Managed float isn’t really a single system, but describes a
continuum of systems
– Smoothing daily fluctuations
– “Leaning against the wind” slowing the change to a different
rate
– Unofficial pegging: actually fixing the rate without
saying so.
– Target-Zone Arrangement: countries agree to maintain
exchange rates within a certain bound What makes target
zone arrangements special is the understanding that
countries will adjust real economic policies to maintain the
zone.
Fixed Rate System: Government maintains target
rates and if rates threatened, central banks buy/sell
currency. A fixed rate system is the ultimate good
news bad news joke. The good is very good and the
bad is very bad.
• Advantage: stability and predictability
• Disadvantage: the country loses control of monetary
policy (note that monetary policy can always be used to
control an exchange rate).
• Disadvantage: At some point a fixed rate may become
unsupportable and one country may devalue. (Argentina
is the most dramatic recent example.) As an alternative to
devaluation, the country may impose currency controls.
A Brief History of the International Monetary
System
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Pre 1875 Bimetalism
1875-1914: Classical Gold Standard
1915-1944: Interwar Period
1945-1972: Bretton Woods System
1973-Present: Flexible (Hybrid) System
The Intrinsic Value of Money and Exchange Rates
• At present the money of most countries has no intrinsic
value (if you melt a quarter, you don’t get $.25 worth of
metal). But historically many countries have backed their
currency with valuable commodities (usually gold or
silver)—if the U.S. treasury were to mint gold coins that
had 1/35th ounces of gold and sold these for $1.00, then a
dollar bill would have an intrinsic value.
• When a country’s currency has some intrinsic value, then
the exchange rate between the two countries is fixed. For
example, if the U.S. mints $1.00 coins that contain 1/35th
ounces of gold and Great Britain mints £1.00 coins that
contain 4/35th ounces of gold, then it must be the case that
£1 = $4 (if not, people could make an unlimited profit
buying gold in one country and selling it in another)
The Classical Gold Standard(1875-1914) had two
essential features
• Nations fixed the value of the currency in terms of
• Gold is freely transferable between countries
• Essentially a fixed rate system (Suppose the US
announces a willingness to buy gold for $200/oz and
Great Britain announces a willingness to buy gold
for £100. Then £1=$2)
Advantage of Gold System
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Disturbances in Price Levels Would be offset by the pricespecie-flow mechanism. When a balance of payments
surplus led to a gold inflow Gold inflow (country with
surplus) led to higher prices which reduced surplus Gold
outflow led to lower prices and increased surplus.
Interwar Period
• Periods of serious chaos such as German hyperinflation
and the use of exchange rates as a way to gain trade
advantage.
• Britain and US adopt a kind of gold standard (but tried to
prevent the species adjustment mechanism from working).
The Bretton Woods System (1946-1971)
• U.S.$ was key currency valued at $1 = 1/35 oz. of gold
• All currencies linked to that price in a fixed rate system.
• In effect, rather than hold gold as a reserve asset, other
countries hold US dollars (which are backed by gold)
Bretton Woods System:
1945-1972
British
pound
German
mark
French
franc
Par
Value
U.S. dollar
Pegged at $35/oz.
Gold
Collapse of Bretton Woods (1971)
• U.S. high inflation rate
• U.S.$ depreciated sharply.
• Smithsonian Agreement (1971) US$ devalued to 1/38 oz. of
gold.
• 1973 The US dollar is under heavy pressure, European
and Japanese currencies are allowed to float
• 1976 Jamaica Agreement
• Flexible exchange rates declared acceptable
• Gold abandoned as an international reserve
Current Exchange Rate Arrangements
• The largest number of countries, about 49, allow market
forces to determine their currency’s value.
• Managed Float. About 25 countries combine government
intervention with market forces to set exchange rates.
• Pegged to another currency such as the U.S. dollar or euro
(through franc or mark). About 45 countries.
• No national currency and simply uses another currency,
such as the dollar or euro as their own.