International Business Chapter 29 Whether The Current System Meets These Requirements Matter Opinion Some Would Say

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CHAPTER 29

THE INTERNATIONAL MONETARY SYSTEM:

Past, Present, and Future

Learning Objectives:

■ Assess the postwar international monetary system known as Bretton Woods.

■ Describe the historical evolution of the international monetary system from Bretton

I. Outline

Introduction

– Monetary System Uncertainties

The Bretton Woods System

– The Goals of the IMF

– The Bretton Woods System in Retrospect

Gradual Evolution of a New International Monetary System

– Early Disruptions

– Special Drawing Rights

– The Breaking of the Gold-Dollar Link and the Smithsonian Agreement

– Controls on Capital Flows

– Greater Stability and Coordination of Macroeconomic Policies across Countries

– International Monetary Arrangements and the Emerging/Developing Countries

Summary

II. Special Chapter Features

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III. Purpose of Chapter

The purpose of this chapter is to acquaint students with the desirable features of an

effective international monetary system, to review the characteristics and problems of the

IV. Teaching Tips

A. Students often fail to appreciate the importance of a smoothly-functioning international

B. In covering the IMF’s balance–of-payments loans, it would be useful to emphasize (as is

also briefly mentioned in the chapter), that the IMF provides other types of loans than just these

balance-of-payments loans. Additional lending has emerged, for example, for compensatory

C. Some updating is periodically necessary with respect to Table 3 on exchange rate

arrangements. These arrangements used to be indicated at the beginning of each month’s issue

of International Financial Statistics but this is no longer the case. It is a little difficult to locate

D. The Tobin proposal for a tax on short-term capital flows continues to be discussed in

view of the huge volume of such flows (over $4 trillion of foreign exchange market transactions

now occur in the world every business day). Hence, it is worthwhile to encourage discussion on

the pros and cons of short-term capital controls.

V. Answers to End-of-Chapter Questions and Problems

1. An effective international monetary system needs to provide for relatively quick and

smooth adjustment to imbalances in countries’ balance–of-payments positions. In addition, if

exchange rates are not completely flexible, there must exist an adequate supply of internationally

acceptable reserve assets so that effective intervention can be carried out without resort to trade

2. The problems with the Bretton Woods system are discussed in the chapter. The current

system may provide greater adjustment of imbalances without undue interference with domestic

3. An SDR is, like gold, an internationally acceptable reserve asset that is not

simultaneously in use as a national currency. In addition, the growth rate of the asset can be kept

relatively low, and the value of the asset is more stable than the value of any single (component)

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4. The growth of the world money supply is dependent on only one source in either system

(the world gold supply in one system, decisions at the world central bank in the other). Both rely

on basically fixed exchange rates, and both have a mechanism for adjustment to imbalances in

5. The original central purposes of the IMF were to provide relative stability in exchange

rates through a pegged-rate system, to combine BOP adjustment with national autonomy in

domestic macroeconomic policies, to encourage freedom in trade and payments (although capital

6. With respect to a flexible-rate system, the target zone proposal permits the exchange rate

to perform its adjustment function to some extent, allows for some protection against the

transmission of real shocks across countries, and prevents speculation from driving currencies to

wide swings. It also allows fiscal policy to perform a role in meeting internal goals. However,

7. The logic of the statement is that coordinated policies would keep real exchange rates

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stable because countries will not be having incompatible inflationary stances, for example. (This

8. Advantages include the decreased exchange rate risk associated with foreign trade and

investment, which would enhance specialization and the gains from trade and would allocate

capital more effectively toward its most productive uses. In addition, if member countries are

VI. Sample Exam Questions

1. Because different inflation/unemployment trade-offs can make it very difficult for a

2. SDRs were first introduced as a means of strengthening the Bretton Woods system. If the

Bretton Woods system had not collapsed soon after the introduction of SDRs, how (if at all)

could SDRs have potentially contributed to alleviating the liquidity problem? The confidence

3. Why did the Bretton Woods system break down? Do you think that that breakdown and

the subsequent adoption of much greater flexibility in the value of the dollar have been “good”

from the standpoint of the United States? Why or why not?

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4. Some economists doubt whether the Bretton Woods system could have survived the

OPEC and primary product price “shocks” of the mid-1970s and the subsequent stagflation

5. Proposals to alter the international monetary system have included (1) a return to the

6. In order for monetary union to occur, why are “convergence criteria” desirable?

7. Compare and contrast the “target zone system” and the “world central bank” system for

8. Do you think that “conditionality” on IMF loans to developing country is desirable or