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InternationalBusiness 1

InternationalBusiness 1

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Published by: Sham on Mar 04, 2012
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07/23/2013

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Discipline

A fixed exchange rate regime imposes discipline in two
ways. First, the need to maintain a fixed exchange rate
puts a brake on competitive devaluations and brings
stability to the world trade environment. Second, a fixed
exchange rate regime imposes monetary discipline on
countries, thereby curtailing price inflation. For example,
consider what would happen under a fixed exchange rate
regime if Great Britain rapidly increased its money
supply by printing poundsFlexibility

Although monetary discipline was a central objective of
the Bretton Woods agreement, it was recognized that a
rigid policy of fixed exchange rates would be too
inflexible. It would probably break down just as the gold
standard had. In some cases, a country's attempts to

149

reduce its money supply growth and correct a persistent
balance-of-payments deficit could force the country into
recession and create high unemployment. The architects
of the Bretton Woods agreement wanted to avoid high
unemployment, so they built some limited flexibility into
the system. Two major features of the IMF Articles of
Agreement fostered this flexibility: IMF lending facilities
and adjustable parities.

The IMF stood ready to lend foreign currencies to
members to tide them over during short periods of
balance-of-payments deficit, when a rapid tightening of
monetary or fiscal policy would hurt domestic
employment. A pool of gold and currencies contributed
by IMF members provided the resources for these
lending operations. A persistent balance-of-payments
deficit can lead to a depletion of a country's reserves of
foreign currency, forcing it to devalue its currency. By
providing deficit-laden countries with short-term foreign
currency loans, IMF funds would buy time for countries
to bring down their inflation rates and reduce their
balance-of-payments deficits. The belief was that such
loans would reduce pressures for devaluation and allow
for a more orderly and less painful adjustment.

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