Transcript International Monetary System

The International Monetary
System
International Finance
Dr. A. DeMaskey
Learning Objectives
 What
different exchange rate systems are used by
various governments?
 What are the characteristics of an ideal currency?
 What currency regime choices do emerging
market countries have?
 How was the euro created and what are its effects?
 What are the origins and proposed mechanisms to
deal with various emerging market currency
crises?
The International Monetary
System (IMS)
 Official
Part of the International Financial
System
 Presents a Structure within which
• Exchange rates are determined
• Trade and capital flows are accommodated
• Balance of payments adjustments are made
 Operates
under a set of policies, institutions,
practices and regulations.
Alternative Exchange Rate
Systems
 Fixed
Rates
 Freely Floating
 Managed Float
 Pegged Exchange Rates
 Target Zone Arrangement
Fixed Exchange Rate Systems
 Gold
Standard (1821-1914)
 Gold Exchange Standard (1925-1931)
 Fixed Rates with Narrow Bands - Bretton
Woods System (1944-1971)
 Fixed Rates with Wider Bands -Smithsonian
Agreement (1971-1973)
Gold Standard (1821-1914)
 Gold
is the dominant international money
 Currencies are valued in terms of a gold
equivalent
 All players had to adhere to the rules of the
game
 Government intervention
 International reserves
 Limited growth of the money supply
 Automatic balance of payment adjustments.
Gold Exchange Standard
(1925-1931)
 Each
currency is freely convertible into gold
at a fixed rate but also into other currencies
at relatively stable prices.
 Greater convenience for international
traders and investors.
Bretton Woods System (1944-1971)
Fixed Rates with Narrow Bands
 A dollar
based system
 Maintain a fixed, or pegged, exchange rate in
terms of gold or the U.S. dollar
 Dollar per gold value of $35.00
 Allow currencies to fluctuate within a
narrow band of ±1%.
 Government intervention
 International reserves
Smithsonian Agreement (1971-1973)
Fixed Rates with Wider Bands
 Dollar
per gold value was changed to
$38.02
 Allow currencies to fluctuate within a wider
band of ±2.25%.
Floating Exchange Rate Systems
 Free
or Clean Float (March 1973)
 Managed or Dirty Float (January 1976)
 Joint Float - European Monetary System
(March 1979)
Freely Floating Exchange Rate
System
 Market
forces determine the exchange rate
 No government intervention
 No need for international reserves
 Independent monetary and fiscal policies
 No capital flow restrictions
 Price instability
Managed Floating Rate System
 Market
forces determine the exchange rate
 Some government intervention
 Jamaica Agreement (January 1976)
 Plaza Agreement (September 1985)
 Louvre Accord (February 1987)
Contemporary Currency Regimes
 IMS
(national currencies, artificial
currencies, composite currency)
 Exchange Rate Regimes (8)
• Rigidly fixed system (euro area)
• Independently floating (developed and
emerging market countries)
Fixed vs. Flexible Exchange
Rates Systems
 Preference
for fixed exchange rates
 Anti-inflationary
 Large international reserves
 Inconsistency with economic fundamentals
Attributes of the Ideal Currency
 Fixed
value
 Convertibility
 Independent
monetary policy
Emerging Markets and Regime
Choices
 A currency
board is a system for
maintaining the value of the local currency
with respect to some other specified
currency.
 Dollarization refers to the replacement of a
local currency with U.S. dollars
Currency Board System
 Argentina
(1991)
 Fixed Rate System
 100% Reserve System
 Monetary Policy and Money Supply
 Dollar-Denominated Accounts (interest
differential)
 End of Argentine Currency Board (2002)
More…
Currency Board System
 Characteristics
• No Central Bank
• No Discretionary Monetary Policy
 Advantages
• Promotes price stability
• Responsible fiscal policy
 Disadvantages
• Sharp contraction in money supply
• High interest rates
Dollarization
 Use
of U.S. dollar as the official currency
• Panama, Ecuador, Liberia
 Requires
change in structure and responsibilities
of monetary policy authorities
 Arguments for:
• Removes currency volatility against dollar
• Expectations of greater economic integration
 Argument
against:
• Loss of sovereignty over monetary policy
• Loss of power of seignorage
• Loss of role of lender of last resort
The Birth of a European
Currency: The Euro
 European
Monetary System
• Target Zone Arrangement
• Pegged Exchange Rate System
• Joint Float Agreement
 European
Monetary Union
• Why Monetary Unification?
• Launch of the Euro
• How to Achieve Monetary Unification?
Target Zone Arrangement
 Member
countries maintain fixed exchange
rates within a flexible range, called target
zone, among themselves.
 Each member’s currency is pegged to all the
other members’ currencies.
 The group as a whole floats jointly against
the rest of the world.
The EMS:
A Joint Float Agreement
 EMS
members peg their currencies to each
other.
 Exchange outside the EMS is subject to a
managed float.
 Objective: Exchange rate stability.
Summary of Historical Events Leading Up
to EMU
1957 Treaty of
Rome - EEC
1972 the
“monetary
Snake”
1979 the European
Monetary System
begins
1991Maastricht
Treaty
1995 Madrid
confirms timetable
1/1/99 conversion
Maastricht Treaty
(December 1991)
 Common
European Currency - Euro
• Fixed rate system
• Replaces individual national currencies
 European
Central Bank (ECB)
• Issues common currency
• Conducts monetary policy
The Maastricht Treaty Criteria
Inflation not to exceed that in three EU states with the
lowest rate by more than 1.5%.
 Long-term interest rates not to exceed that in three
EU states with the lowest inflation rates by more than
2%.
 The annual fiscal deficit not to exceed 3% of GDP.
 Cumulative public debt not to exceed 60% of GDP.
 A country must have maintained its membership in
the EMS for two years without having initiated a
devaluation.

Milestones on the Road to
Monetary Union





Dec. 31, 1999
Euro exchange rates are fixed. ECB takes over monetary
policy for all eleven EMU nations.
Jan. 4, 1999
Stock and bond markets convert to euro.
1999-2001
Foreign exchange transactions denominated in euros.
Jan. 1, 2002 (E-Day)
Euro notes and coins must be in circulation in all EMU
member states.
July 1, 2002
National currencies no longer legal tender.
Monetary Unification
 Why
Monetary Unification?
• A single currency area called euro zone
• Competing globally
 How
to Achieve Monetary Unification
• Fiscal policy
• Monetary policy
• Fixing the value of the euro
 Performance
of The Euro
Useful Websites
 A table
showing the currencies of the world and
their exchange rate arrangements can be found at:
• http://pacific.commerce.ubc.ca/xr/currency_table.html
 For
more information on the euro, visit:
• http://www.euro.ecb.int/en.html
• http://www.ecb.int/
• http://pacific.commerce.ubc.ca/xr/euro/
Emerging Market Currency
Crises
 Currency
•
•
•
•
Crises
Mexican crisis of 1994-1995
Asian crisis of 1997
Russian crisis of 1998
Brazilian crisis of 1998-1999
 Transmission
Mechanisms
• Trade Links
• Financial System
More…
Emerging Market Currency
Crises
 Origins
• Moral Hazard
• Fundamental Policy Conflict
 Policy
Proposals
• Currency Controls
• Free Float
• Fixed Exchange Rates