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Chapter 11 - The International Monetary System
11-1
The International Monetary System
Learning objectives
• Explain the role played by the
World Bank and the IMF in the
• Identify exchange rate regimes
used in the world today and
why countries adopt different
exchange rate regimes.
This chapter discusses the evolution of the international
monetary system and the implications of this system for
international business, focusing on the institutional context
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
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.
11
Chapter 11 - The International Monetary System
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OUTLINE OF CHAPTER 11: THE INTERNATIONAL MONETARY
SYSTEM
Opening Case: Iceland’s Economic Recovery
Introduction
The Gold Standard
Mechanics of the Gold Standard
The Collapse of the Fixed Exchange Rate System
The Floating Exchange Rate Regime
The Jamaica Agreement
Country Focus: The U.S. Dollar, Oil Prices, and Recycling Petrodollars
Fixed versus Floating Exchange Rates
Exchange Rate Regimes in Practice
Pegged Exchange Rates
Currency Boards
Crisis Management by the IMF
Financial Crises in the Post-Bretton Woods Era
Evaluating the IMF’s Policy Prescriptions
Chapter 11 - The International Monetary System
Management Focus: Airbus and the Euro
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.
OPENING CASE: Iceland’s Economic Recovery
The opening case explores the economic recovery of Iceland—thanks to loans from the
International Monetary Fund (IMF) and from other countries. Iceland’s three biggest
banks had been expanding at a breakneck pace since 2000 until the global crisis in 2008.
The Icelandic banks, in their swift growth period, started to expand into other
1. Why was it so important for the IMF to step in to help Iceland? What were the
potential implications of Iceland’s debt crisis for other countries? How might the crisis
have impacted the entire international monetary system?
2. How did the IMF help Iceland? What impact did it have the country’s economy and
prospects for future growth?
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3. Discuss Iceland’s approach to shoring up the country’s economy—not by austerity
measures but by providing subsidies to local homeowners. Would this approach have
worked in other larger countries? How did the slumping value of the krona actually help
get the country back on its feet economically speaking?
LECTURE OUTLINE FOR CHAPTER
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 11-6 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.
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
Chapter 11 - The International Monetary System
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The Bretton Woods system also provided for two multinational institutions – the
International Monetary Fund (IMF) and the World Bank (IBRD).
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.
The World Bank is also known as the International Bank for Reconstruction and
Development (IBRD).
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
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.
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The case for floating exchange rates has three main elements:
1. monetary policy autonomy
Supporters of fixed exchange rates focus on monetary discipline, uncertainty, and the
lack of connection between the trade balance and exchange rates.
Slide 11-20 Who Is Right?
There is no real agreement as to which system is better.
Slides 11-21- and 11-22 Exchange Rate Regimes in Practice
Currently:
• 21% of IMF members follow a free float policy
Slide 11-23 Pegged Exchange Rates
A country following a pegged exchange rate system, pegs the value of its currency to
that of another major currency.
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.
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Slides 11-29 through 11-32 The Asian Crisis
The 1997 Southeast Asian financial crisis was caused by a series of events that took place
in the previous decade.
Slides 11-33 and 11-34 Evaluating the IMF Policy Prescriptions
Critics of the IMF worry:
• the “one-size-fits-all” approach to macroeconomic policy is inappropriate for
Slides 11-35 and 11-36 Implications for Managers
The present floating rate system mandates that firms carefully manage their foreign
exchange transactions and exposures.
CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: Why did the gold standard collapse? Is there a case for returning to some
type of gold standard? What is it?
ANSWER 1: The gold standard worked reasonably well from the 1870s until the start of
World War I in 1914, when it was abandoned. During the war several governments
financed their massive military expenditures by printing money. This resulted in
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QUESTION 2: What opportunities might current IMF lending policies to developing
nations create for international businesses? What threats might they create?
ANSWER 2: The IMF lending policies require the recipient countries to implement
governmental reforms to stabilize monetary policy and encourage economic growth. One
QUESTION 3: Do you think the standard IMF policy prescriptions of tight monetary
policy and reduced government spending are always appropriate for developing nations
experiencing a currency crisis? How might the IMF change its approach? What would
the implications be for international business?
ANSWER 3: Critics argue that the tight macroeconomic policies imposed by the IMF in
the recent Asian crisis are not well suited to countries that are suffering not from
QUESTION 4: Debate the relative merits of fixed and floating exchange rate regimes.
From the perspective of an international business, what are the most important criteria for
choosing between the systems? Which system is the more desirable for an international
business?
ANSWER 4: The case for fixed exchange rates rests on arguments about monetary
discipline, speculation, uncertainty, and the lack of connection between the trade balance
and exchange rates. In terms of monetary discipline, the need to maintain fixed exchange
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QUESTION 5: Imagine that Canada, the United States, and Mexico decide to adopt a
fixed exchange rate system. What would be the likely consequences of such a system for
(a) international businesses, and (b) the flow of trade and investment among the three
countries?
ANSWER 5: Were North America to adopt a common currency, it would become
increasingly attractive for foreign investment and would increase trade and investment
QUESTION 6: Reread the Country Focus on the U.S. dollar, oil prices and recycling
petrodollars, then answer the following questions:
a. What will happen to the value of the U.S. dollar if oil producers decide to invest most
of their earnings from oil sales in domestic infrastructure projects?
b. What factors determine the relative attractiveness of the dollar-, euro-, and yen-
denominated assets to oil producers flush with petrodollars? What might lead them to
direct more funds toward non-dollar-denominated assets?
c. What will happen to the value of the U.S. dollar if OPEC members decide to invest
more of their petrodollars towards non-dollar assets, such as euro denominated stocks and
bonds?
d. In addition to oil producers, China is also accumulating a large stock of dollars,
currently estimated to total $1.4 trillion. What would happen to the value of the dollar if
China and oil-producing nations all shifted out of dollar-denominated assets at the same
time? What would be the consequences for the United States economy?
ANSWER 6: a. If oil producers decide to invest their earnings in domestic infrastructure
projects, it would be expected that the countries involved would see a boost in economic
Chapter 11 - The International Monetary System
CLOSING CASE: Currency Trouble in Malawi
The closing case explores how Malawi’s economic fortunes have changed over the past
decade. When former World Bank economist Bingu wa Mutharika became president of
Malawi in 2004, it seemed to be the beginning of a new era for one of the world’s poorest
nations—thanks to Mutharika. However, things changed for the worst in his second term,
as Mutharika became dictatorial, expelled foreign ambassadors who criticized him, and
watched the country’s top export—tobacco—go nowhere. In the middle of a full-blown
currency crisis in 2011, the country turned to the IMF, which wanted Mutharika to
devalue the local currency (the kwacha). He refused and sent the country into a tailspin
until his death in 2012. With pressure from the United States and the UK, Malawi
devalued its currency, which prompted the IMF to step in and restart its loan program
with the country. Discussion of the case can revolve around the following questions:
QUESTION 1: What were the causes of Malawi’s currency troubles?
ANSWER 1: In addition to the dictatorship of the country’s then president, the country’s
QUESTION 2: Why did Mutharika resist IMF calls for currency devaluation? If he had
lived and remained in power, what do you think would have happened to the economy of
Malawi assuming that he did not change his position?
ANSWER 2: Mutharika thought devaluing the currency would cause price inflation and
hurt the country’s already poor population. If he had remained in power, anti-government
Chapter 11 - The International Monetary System
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QUESTION 3: Now that Malawi’s currency has been devalued, what do you think the
economic consequences will be? Is this good for the economy?
ANSWER 3: With a devalued currency, Malawi’s exports may be able to help the
country recover from severe financial woes. Because of its willingness to work with the
INTEGRATING iGLOBES
There are several iGLOBE video clips that can be integrated with the material presented
in this chapter. In particular, you might consider the following:
Title: World Bank: Doing Business Report 2012
Run Time: 2:36
Abstract: This video describes the findings of a report by the World Bank on the ease of
doing business around the world.
Key Concepts: globalization, economic differences, investment, market reform, World
Bank, trade policy, political economy, global economy
Notes: A recent report by the World Bank and the IFC revealed that several countries in
Asia now top the list as the easiest places in the world in which to do business. In
World Bank Group Director of Global Indicators and Analysis Augusto Lopez-Claros is
excited about the changes in the Doing Business In Report noting that in the past many
countries moved up on the list by focusing on making easy changes. In contrast, this new
report shows that the several of the countries that have emerged at the top of the list have
Sub-Saharan Africa for example, has made substantial improvements by replacing time
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consuming paperwork with a new electronic filing procedure. In fact, some 100
economies around the world now use electronic filing for services ranging from business
registration to customs clearance and court filings.
Discussion Questions and Answers
1. Discuss how policy changes in China and India have facilitated business and created a
more open environment for investment. What are the implications of these changes for
economic development in the countries?
Answer: The new report by the World Bank and IFC reveals that over the last six years
both India and China have focused on making significant changes designed to make it
2. What are the benefits to countries like India that have implemented reforms designed
to not only attract more investment from local companies, but also from foreign
investors?
Answer: India has implemented many reforms intended to create a better business
environment. Most students will probably recognize the link between attracting new
3. Why is the introduction of electronic filing procedures in Sub-Saharan Africa
important to economic development in the region? How will the new procedures help
encourage entrepreneurship?
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Answer: The introduction of electronic filing procedures has reduced costs and
bureaucracy for companies doing business in the region. This of course is beneficial for
4. Imagine that you are the head of a company considering investing in South Korea,
China, or India. What might make one country more attractive than another? How
would you characterize the cost of doing business in these markets?
Answer: Many students will probably suggest that despite the reforms that have recently
taken place in these markets, they remain risky for new investors. Some students may
INTEGRATING VIDEOS
There are also several longer video clips that can be integrated with the material
presented in this chapter. In particular, you might consider the following from
International Business DVD Volume 6:
Title: Bank Launches Partnership for ‘Green Accounting’
Learning Objectives
The purpose of this video is to help you:
❖ Understand the nature of natural capital and environmental sustainability.
Key Words
❖ Globalization
❖ Environmental sustainability
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❖ Ethics
❖ World Bank
Synopsis
The World Bank is launching a new program designed to help developing countries
better manage their natural capital. The World Bank is concerned that without the proper
knowledge of how to value natural resources, these countries could lose their ecosystems,
The World Bank’s new program, which is being offered in partnership with the United
Nation’s Environmental Program, involves providing developing countries with the tools
for ‘green accounting.’ The goal is to ensure that a country’s finance minister has a full
understanding of the economic implications of decisions that involve the nation’s natural
resources. It is hoped that this will help avoid the type of exploitation by multinational
companies that can limit future economic growth in a country, and degrade the
1. Explain the concept of natural capital. Why is the World Bank concerned about
protecting the natural capital of developing countries?
2. What is “green accounting’? How is the World Bank working to identify the necessary
tools for the task? Why is it so difficult to value natural capital?
3. What role do multinational companies play in the environmental degradation taking
place in many developing countries? Why do developing countries permit investments
by the companies? What responsibilities do these companies have to the host countries?
Chapter 11 - The International Monetary System
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4. Discuss how companies can use ‘green accounting’ methods and tools to incorporate
social and environmental goals with their business strategies. How might promoting a
greener approach to strategy help companies be more profitable in the long run?
INCORPORATING globalEDGE™ EXERCISES
Exercise 1
The Global Financial Stability Report is a semiannual report published by the
International Capital Markets division of the International Monetary Fund (IMF). The
report includes an assessment of the risks facing the global financial markets. Locate and
download the latest report to get an overview of the most important issues currently under
discussion. Also, download a report from five years ago. How do the issues from five
years ago compare with financial issues identified in the current report?
Exercise 1 Answer
Search phrase: Global Financial Stability Report
Resource Name: IMF: Global Financial Stability Report
Exercise 2
An important element to understanding the international monetary system is keeping
updated on current growth trends worldwide. A German colleague told you yesterday that
Deutsche Bank Research provides an effective way to stay informed on important topics
in international finance from a European perspective. Find an emerging market research
report for analysis. On which emerging market region did you choose to focus? What are
the key takeaways from your chosen report?
Exercise 2 Answer
Search phrase: Deutsche Bank Research
Chapter 11 - The International Monetary System
