Chapter 11 – The International Monetary System
The International Monetary System
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Chapter 11 – The International Monetary System
Learning objectives
Describe the historical development of the modern global monetary system.
Explain the role played by the World Bank and the IMF in the international monetary
system.
Compare and contrast the differences between a fixed and a floating exchange rate
system.
Identify exchange rate regimes used in the world today and why countries adopt
different exchange rate regimes.
Understand the debate surrounding the role of the IMF in the management of
financial crises.
Explain the implications of the global monetary system for currency management and
business strategy.
This chapter discusses the evolution of the international monetary system and the
implications of this system for international business, focusing on the institutional context
within which exchange rates move.
The history of monetary systems includes a period with the gold standard, a fixed
exchange rates system, and the current managed float system. Since WWII, the IMF and
the World Bank have played an important role in the world economy
The role of the IMF is to maintain order in the international monetary system to avoid a
repetition of the competitive devaluations of the 1930s, and to control price inflation by
imposing monetary discipline on countries.
IMF-mandated macro economic policies are under serious debate, with critics charging
that at times the IMF imposes inappropriate conditions on developing nations.
The opening case explores the recent political and economic crisis in Ukraine and the
attempts by the IMF to restore stability to the country’s currency value and to promote
economic growth. The closing case explores the recent debt crisis in Iceland and the
country’s economic recovery thanks to a floating currency exchange rate and loans from
the IMF.
OUTLINE OF CHAPTER 11: THE INTERNATIONAL MONETARY
SYSTEM
Opening Case: The IMF and Ukraine’s Economic Crisis
Introduction
The Gold Standard
Mechanics of the Gold Standard
Strength of the Gold Standard
The Period between the Wars, 1918-1939
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Chapter 11 – The International Monetary System
The Bretton Woods System
The Role of the IMF
The Role of the World Bank
The Collapse of the Fixed Exchange Rate System
The Floating Exchange Rate Regime
The Jamaica Agreement
Exchange Rates Since 1973
Country Focus: The U.S. Dollar, Oil Prices, and Recycling Petrodollars
Fixed versus Floating Exchange Rates
The Case for Floating Exchange Rates
The Case for Fixed Exchange Rates
Who Is Right?
Exchange Rate Regimes in Practice
Pegged Exchange Rates
Currency Boards
Crisis Management by the IMF
Financial Crises in the Post-Bretton Woods Era
Country Focus: The Mexican Currency Crisis of 1995
Evaluating the IMF’s Policy Prescriptions
Implications for Managers
Currency Management
Business Strategy
Management Focus: Airbus and the Euro
Corporate-Government Relations
Chapter Summary
Critical Thinking and Discussion Questions
Closing Case: The IMF and Iceland’s Economic Recovery
CLASSROOM DISCUSSION POINT
Ask students how much their currency is worth. Try to get them to identify its value in
terms of another currency. Then ask students how they might know the value of the
currency. Students will probably indicate options like the posting at the currency kiosk at
the airport, or the rates that are printed in the newspaper or are available online.
Dig a little deeper, and try to get students to identify some of the factors that could
influence the value of a currency.
Next, ask students what happens to currency values each day, and why. Try to get
students to recognize the idea of a floating exchange rate system.
Finally, link this discussion to the evolution of the current international monetary system.
LECTURE OUTLINE
This lecture outline follows the Power Point Presentation (PPT) provided along with this
instructor’s manual. The PPT slides include additional notes that can be viewed by
clicking on “view,” then on “notes.” The following provides a brief overview of each
Power Point slide along with teaching tips, and additional perspectives.
Slides 11-3 through 11-5 What Is the International Monetary System?
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Chapter 11 – The International Monetary System
The international monetary system refers to the institutional arrangements that countries
adopt to govern exchange rates. Governments adopt various types of exchange rate
systems including the pegged rate, the dirty float, and the fixed rate.
Slides 11-6 and 11-7 The Gold Standard
The system of exchange rates known as the gold standard dates back to ancient times
when gold coins were a medium of exchange, unit of account, and store of value.
Pegging currencies to gold and guaranteeing convertibility is central to the gold standard.
In the 1880s, most of the world’s trading nations followed this exchange rate system.
Slides 11-8 and 11-9 Strength of the Gold Standard
The gold standard provides a powerful mechanism to pull trade imbalances between
countries back into balance-of-trade equilibrium.
Another Perspective: The Advantages Of The Gold Standard was the topic of a 1961
paper by former Federal Reserve Board Chairman, Alan Greenspan. The paper is
available at {http://www.usagold.com/gildedopinion/Greenspan.html}.
The gold standard worked fairly well from the 1870s until the start of World War I in
1914, but by 1939 the gold standard had collapsed.
Slides 11-10 and 11-11 The Bretton Woods System
The Bretton Woods system established a fixed exchange rate system where all currencies
were fixed to gold, but only the U.S. dollar was directly convertible to gold.
Devaluations could not to be used for competitive purposes and a country could not
devalue its currency by more than 10% without IMF approval.
The Bretton Woods system also provided for two multinational institutions – the
International Monetary Fund (IMF) and the World Bank (IBRD).
Another Perspective: For more information about the Bretton Woods Agreement go to
{http://avalon.law.yale.edu/20th_century/decad047.asp} and also at
{http://www.econ.iastate.edu/classes/econ355/choi/bre.htm}.
Slides 11-12 and 11-13 The IMF and the World Bank
The IMF was charged with executing the main goal of the Bretton Woods agreement –
avoiding a repetition of the chaos that occurred between the wars through a combination
of discipline and flexibility.
Another Perspective: The homepage of the IMF is available at {http://www.imf.org}.
Students can click on either “For First Time Visitors” or on “For Students” to get a good
overview of the IMF and its activities.
The World Bank is also known as the International Bank for Reconstruction and
Development (IBRD).
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McGraw-Hill Education.
Chapter 11 – The International Monetary System
Another Perspective: For more information on the World Bank, go to
{http://www.worldbank.org/index.html}. Click on “Data” to pull information on World
Bank activities, or on “Countries” to explore World Bank activities by country.
Slide 11-14 The Collapse of the Fixed Exchange System
The Bretton Woods worked well until the late 1960s, before collapsing.
Slide 11-15 The Floating Exchange Rate Regime
The Jamaica Agreement was signed in 1976 following the collapse of Bretton Woods.
The rules that were agreed on then are still in place today.
Under the Jamaica agreement:
floating rates were declared acceptable
gold was abandoned as a reserve asset
total annual IMF quotas were increased to $41 billion
Slides 11-16 and 11-17 Exchange Rates since 1973
Exchange rates have become more volatile and less predictable than they were between
1945 and 1973.
Slide 11-18 Think Like a Manager: Floating Exchange Rates and Foreign Exchange Risk
Slides 11-19 and 11-20 Fixed Versus Floating Exchange Rates
The merit of a fixed exchange rate versus a floating exchange rate system continues to be
debated.
The case for floating exchange rates has three main elements:
1. monetary policy autonomy
2. automatic trade balance adjustments
3. help countries recover from financial crises
Supporters of fixed exchange rates focus on monetary discipline, uncertainty, and the lack
of connection between the trade balance and exchange rates.
Slide 11-21 Who Is Right?
There is no real agreement as to which system is better.
Slides 11-22- and 11-23 Exchange Rate Regimes in Practice
Currently:
21% of IMF members follow a free float policy
23% of IMF members follow a managed float system
5% of IMF members have no legal tender of their own (excluding EU countries)
the remaining countries use less flexible systems such as pegged arrangements, or
adjustable pegs
Slide 11-24 Pegged Exchange Rates
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Chapter 11 – The International Monetary System
A country following a pegged exchange rate system, pegs the value of its currency to
that of another major currency.
Slide 11-25 Currency Boards
Countries using a currency board commit to converting their domestic currency on
demand into another currency at a fixed exchange rate.
Slides 11-26 through 11-28 Crisis Management by the IMF
Today, the IMF focuses on lending money to countries experiencing financial crises.
A currency crisis occurs when a speculative attack on the exchange value of a currency
results in a sharp depreciation in the value of the currency, or forces authorities to expend
large volumes of international currency reserves and sharply increase interest rates in
order to defend prevailing exchange rates.
A banking crisis refers to a situation in which a loss of confidence in the banking system
leads to a run on the banks, as individuals and companies withdraw their deposits.
A foreign debt crisis is a situation in which a country cannot service its foreign debt
obligations, whether private sector or government debt.
Slide 11-29 Mexican Currency Crisis of 1995
The Mexican currency crisis of 1995 was a result of:
high Mexican debts
a pegged exchange rate that did not allow for a natural adjustment of prices
Slides 11-30 through 11-33 The Asian Crisis
The 1997 Southeast Asian financial crisis was caused by a series of events that took place
in the previous decade.
Slides 11-34 and 11-35 Evaluating the IMF Policy Prescriptions
Critics of the IMF worry:
the “one-size-fits-all” approach to macroeconomic policy is inappropriate for
many countries
the IMF is exacerbating moral hazard (when people behave recklessly
because they know they will be saved if things go wrong)
The IMF has become too powerful for an institution without any real
mechanism for accountability
Slides 11-36 and 11-37 Implications for Managers
The present floating rate system mandates that firms carefully manage their foreign
exchange transactions and exposures.
Managers must recognize that the current international monetary system is a managed
float system in which government intervention can help drive the foreign exchange
market.
Managers need strategic flexibility.
Companies should promote an international monetary system that facilitates international
growth and development.
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McGraw-Hill Education.