CHAPTER 2
THE INTERNATIONAL MONETARY SYSTEM
1. The Rules of the Game. Under the gold standard, all national governments promised
to follow the “rules of the game.” What did this mean?
A country’s money supply was limited to the amount of gold held by its central bank
or treasury. For example, if a country had 1,000,000 ounces of gold and its fixed rate
2. Defending a Fixed Exchange Rate. What did it mean under the gold standard to
‘defend a fixed exchange rate’, and what did this imply about a country’s money
supply?
Under the gold standard a country’s central bank was responsible for preserving the
exchange value of the country’s currency by being willing and able to exchange its
3. Bretton Woods. What was the foundation of the Bretton Woods international
monetary system, and why did it eventually fail?
Bretton Woods, the fixed exchange rate regime of 1945-1973, failed because of
widely diverging national monetary and fiscal policies, differential rates of inflation,
and various unexpected external shocks. The U.S. dollar was the main reserve
currency held by central banks and was the key to the web of exchange rate values.
4. Technical Float. Speaking very specifically – technically, what does a floating rate
of exchange mean? What is the role of government?
A truly floating currency value means that the government does not set the currency’s
5. Fixed Exchange Rate. Why do many emerging market economies prefer to adopt a
fixed exchange rate?
Many emerging economies resort to pegging their domestic currencies against major
currencies. In emerging nations that are dependent on imports, a floating rate can
6. De facto and de jure. What do the terms de facto and de jure mean in reference to
the International Monetary Fund’s use of the terms?
7. Exchange Rates. Why do many developing countries fix their currencies while
emerging economies adopt a crawling peg?
In most cases, when developing nations peg or fix their domestic currency, they keep
it devalued to increase the price competitiveness of their exports and to curb imports.
Not only does this help fix balance-of-payments deficits, but it also supports
economic growth, creates jobs, and protects domestic industries. The high level of
8. Global Eclectic. What does it mean to say the international monetary system today
is a global eclectic?
The current global market in currency is dominated by two major currencies, the U.S.
9. The Impossible Trinity. With reference to the impossible trinity, what are the
possible policy mixes that a nation could have?
▪ No capital controls + an independent monetary policy (the United States and
Western Europe)
10. Eurozone Central Banks. How does the European Central Bank operate and what
is its relationship with the central banks of the various jurisdictions of the Eurozone?
The European Central Bank (ECB) is the central bank for the Eurozone; that is, the
European countries that have adopted the euro. The national central banks are the
holders of the capital of the ECB. The main functions of the ECB are to implement
European monetary policy, manage foreign reserves, and ensure the smooth
11. Currency Boards. What is the difference between central banks and currency
boards?
A currency board is a monetary authority that is committed to adopt a pegged
exchange rate while renouncing independent monetary policy. Similar to a central
bank, a currency board issues notes and coins that it pegs to a foreign currency or a
12. Argentine Currency Board. How did the Argentine currency board function from
1991 to January 2002 and why did it collapse?
Argentina’s currency board exchange regime of fixing the value of its peso on a one-
to-one basis with the U.S. dollar ended for several reasons:
▪ These two problems, in turn, led to continued trade deficits and a loss of foreign
exchange reserves by the Argentine central bank. (4) This problem, in turn, led
Argentine residents to flee from the peso and into the dollar, further worsening
Argentina’s ability to maintain its one–to-one peg.
13. SDRs. What are the advantages and disadvantages of Special Drawing Rights
(SDRs)?
Special Drawing Rights (SDRs) were created by the IMF in 1969 when the supply of
two key reserve assets (the US dollar and gold) proved inadequate for supporting the
expansion of international trade. SDRs are potential claims on the convertible
currencies of IMF members. SDRs can be used in exchanges between trade partners.
Their main advantage to members with weak external positions is that the IMF can
designate more developed nations to purchase SDRs from these financially weaker
countries. Another major advantage is that the SDR is relatively stable. It is also used
as the unit of account by the IMF and other international institutions. Moreover,
14. Currency Strength. Is a strong currency good or bad for the domestic economy?
The answer to this question is not as straightforward as some might think. A currency
appreciates when its value rises in comparison to other currencies, allowing it to buy
more units of imports. The overall impact of a stronger domestic currency depends on
the strength of the domestic currency as well as on the structure of the economy. At
the macroeconomic level, a stronger currency reduces the price of imports; that is, it
makes imports more affordable to domestic consumers as well as to firms that import
foreign inputs or spare parts. However, industries that compete with the imported
system. But the caveat is that this should not be prolonged but should only last till
infant industries grow large enough to replaced some of the reliance on imports.
15. Fixed Exchange Rates in Emerging Market Economies. What are the methods
available to an emerging market economy if it elects to adopt a pegged exchange rate
system? What is the ideal system if it needs to manage inflation and economic
growth?
In regard to the exchange system, emerging market economies have three
alternatives: float their currencies, adopt a managed float system, or totally peg their
currency. In the case of managed floats, the domestic currency is left to float freely,
but the central bank of the nation regularly intervenes if the currency moves outside a
given band. The pegged foreign exchange system can be implemented through
official pegs against a single currency or a basket of major currencies. The least
16. Globalizing the Yuan. What are the major changes and developments that must
occur for the Chinese yuan to be considered ‘globalized’?
First, the yuan must become readily accessible for trade transaction purposes. This is
the fundamental and historical use of currency. Secondly, it then needs to mature
17. Triffin Dilemma. What is the Triffin Dilemma? How does it apply to the
development of the Chinese yuan as a true global currency?
The Triffin Dilemma is the potential conflict in objectives that may arise between
domestic monetary and currency policy objectives and external or international policy
18. China and the Impossible Trinity. What choices do you believe that China will
make in terms of the Impossible Trinity as it continues to develop global trading and
use of the Chinese yuan?
This is purely speculative opinion, but many believe China will continue to move the
yuan toward globalization rapidly. As Chinese financial institutions and policies
