Presented by
ROOPESH M
IMK KOLLAM
ALTERNATIVE EXCHANGE RATE SYSTEMS
A BRIEF HISTORY OF THE INTERNATIONAL
MONETARY SYSTEM
THE EUROPEAN MONETARY SYSTEM
Costs and benefits of a single currency
People trade currencies for two primary
reasons
◦ To buy and sell goods and services
◦ To buy and sell financial assets
Freely Floating
Managed Float
Target Zone
Fixed Rate
Even though we may call it “free float” in fact
the government can still control the exchange
rate by manipulating the factors that affect
the exchange rate (i.e., monetary policy)
price levels
interest rates
economic growth
Market forces set rates unless excess volatility occurs,
then, central bank determines rate by buying or selling
currency. Managed float isn’t really a single system, but
describes a continuum of systems
◦ Smoothing daily fluctuations
◦ “Leaning against the wind” slowing the change to a
different rate
◦ Unofficial pegging: actually fixing the rate without
saying so.
◦ Target-Zone Arrangement: countries agree to
maintain exchange rates within a certain bound What
makes target zone arrangements special is the
understanding that countries will adjust real economic
policies to maintain the zone.
Advantage: stability and predictability
Disadvantage: the country loses control of
monetary policy (note that monetary policy can
always be used to control an exchange rate).
Disadvantage: At some point a fixed rate may
become unsupportable and one country may
devalue. (Argentina is the most dramatic recent
example.) As an alternative to devaluation, the
country may impose currency controls.
Pre 1875 Bimetalism
1875-1914: Classical Gold Standard
1915-1944: Interwar Period
1945-1972: Bretton Woods System
1973-Present: Flexible (Hybrid) System
At present the money of most countries has no
intrinsic value (if you melt a quarter, you don’t
get $.25 worth of metal). But historically many
countries have backed their currency with
valuable commodities (usually gold or silver)—if
the U.S. treasury were to mint gold coins that had
1/35th ounces of gold and sold these for $1.00,
then a dollar bill would have an intrinsic value.
When a country’s currency has some intrinsic
value, then the exchange rate between the two
countries is fixed. For example, if the U.S. mints
$1.00 coins that contain 1/35th ounces of gold
and Great Britain mints £1.00 coins that contain
4/35th ounces of gold, then it must be the case
that £1 = $4 (if not, people could make an
unlimited profit buying gold in one country and
selling it in another)
Nations fixed the value of the currency in
terms of
Gold is freely transferable between countries
Essentially a fixed rate system (Suppose the
US announces a willingness to buy gold for
$200/oz and Great Britain announces a
willingness to buy gold for £100. Then £1=$2)
Disturbances in Price Levels Would be offset
by the price-specie-flow mechanism. When a
balance of payments surplus led to a gold
inflow Gold inflow (country with surplus) led
to higher prices which reduced surplus Gold
outflow led to lower prices and increased
surplus.
Periods of serious chaos such as German
hyperinflation and the use of exchange rates
as a way to gain trade advantage.
Britain and US adopt a kind of gold standard
(but tried to prevent the species adjustment
mechanism from working).
U.S.$ was key currency valued at $1 = 1/35
oz. of gold
All currencies linked to that price in a fixed
rate system.
In effect, rather than hold gold as a reserve
asset, other countries hold US dollars (which
are backed by gold)
Bretton Woods System:
1945-1972
German
British mark French
pound franc
r Par P
Pa lue Va ar
Value lue
Va
U.S. dollar
Pegged at $35/oz.
Gold
U.S. high inflation rate
U.S.$ depreciated sharply.
Smithsonian Agreement (1971) US$ devalued
to 1/38 oz. of gold.
1973 The US dollar is under heavy pressure,
European and Japanese currencies are
allowed to float
1976 Jamaica Agreement
Flexible exchange rates declared acceptable
Gold abandoned as an international reserve
The largest number of countries, about 49, allow
market forces to determine their currency’s
value.
Managed Float. About 25 countries combine
government intervention with market forces to
set exchange rates.
Pegged to another currency such as the U.S.
dollar or euro (through franc or mark). About 45
countries.
No national currency and simply uses another
currency, such as the dollar or euro as their own.
