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International Monetary Fund

Historical perspective on exchange rate
• Gold Standard • International Monetary Fund

• Exchange Rate Regimes – Fixed and Fluctuating
• Euro and its evolution and current challenges


Exchange Rate Regimes Definition
The mechanism, procedures and institutional framework for determining exchange rates at a point in time and changes in them over time, including factors which induce the changes.


Gold Standard System
• Gold Specie Standard • Gold bullion Standard

• Gold Exchange Standard
• Mint Parity Exchange Rate • Three rules under Gold Standard

– Fix once & for all rate of conversion of paper money
– Free flow of gold – Money Supply

Gold Standard
• Originated in the early stages of trade where countries used gold coins as medium of exchange of goods purchased.

• As the volume of trade started increasing, shipping large quantities of gold became impractical. • Countries adopted to exchange through paper currency


Gold Standard • Pegging currencies to gold and guaranteeing convertibility is known as the Gold Standard. • By 1880. US dollar was defined as 23. GB. Germany. one ounce of gold cost was $20.22) 6 . Japan and US had adopted Gold Standard • Value of currency was determined with respect to the gold • For instance.67(480/23.22 gms of fine pure gold • Since 480 grains in an ounce.

Gold Standard • The amount of currency required to buy one ounce of gold was referred to as gold par value.25) . • GB pound was defined as containing 113 grains of fine gold • So exchange value of pound was 4.25 (480/113) • From the gold values of pound and dollar we can compute exchange rate for converting pounds into dollars • 1 pound = $4.67/4.87 (20.

GB in 1925 and France in 1928 8 . and this increased price levels in US GB. money supply and prices help automatic adjustment of deficit/surplus • Gold Standard was in practice from 1870 till 1914 • I World War in 1914 forced countries to print money for military expenses.Strength of the Gold Standard • Used as a balance of payments equilibrium • US and Japan – trade surplus and deficit gets corrected by inflow and outflow of gold • The relationship among Gold flows. France • US returned to gold std in 1919.

24 9 .67 per ounce to $35 per ounce.87 and became $8. • US followed suit in 1933 but returned to Gold Std in 1934 by raising dollar price of gold from $20. • This effectively is devaluation of dollar • Pound was $4.1918-1939 • Inflation in UK made foreign holders of pounds losing confidence and government found difficult to satisfy demand for gold by depleting gold reserves and so suspended convertibility in 1931.

1918-1939 • Reducing price of US exports and increasing price of imports. US government boosted employment and output • This prompted other countries to competitive devaluations and no country could win. • This resulted in shattering confidence in the system and by 1939 this system was suspended by all the countries .

S.constituted • The International Monetary Fund—also known as the “IMF” or the “Fund” • —was conceived at a United Nations conference convened in Bretton Woods.IMF . U. New Hampshire. 11 . • The 45 governments represented at that conference sought to build a framework – for economic cooperation that would avoid a repetition of the disastrous economic policies that had contributed to the Great Depression of the 1930s. in July 1944.

IMF . • The Articles of the IMF Agreement came into force on December 27. 1945. • The principle architects of the IMF at the Bretton Woods Conference were Fabian Society member John Maynard Keynes and the Assistant Secretary of the United States Treasury. 1944. United States. and it began financial operations on March 1.History and Background • Agreement for its creation came at the United Nationssponsored Monetary and Financial Conference in Bretton Woods. as part of a post-WWII reconstruction plan. on July 22. 1947. the organization came into existence in May 1946. 12 . Harry Dexter White. New Hampshire.

a country must normally agree to terms set forth by all three organizations. and strategic World Bank development loans. along with the Bank for International Settlements (BIS) and the World Bank.History and Background • It is sometimes referred to as a “Bretton Woods institution". BIS privilege. In order to gain access to IMF loans. 13 . its twin organization. these three institutions define the monetary policy shared by almost all countries with market economies. • Together.

The IMF describes itself as: “An organization of 184 countries. working to foster global monetary cooperation. 14 . secure financial stability. and reduce poverty”. promote high employment and sustainable economic growth. facilitate international trade.

The IMF's Purposes • • To promote international monetary cooperation To facilitate the expansion and balanced growth of international trade • • To promote exchange stability To assist in the establishment of a multilateral system of payments in respect of current transactions 15 .

• .IMF Functions • To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards In accordance with the above. to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members.

– convert US $ freely into gold at a fixed parity of $35 per ounce • Other IMF member countries-Fix parities of currencies to US dollar with 1% variation • Commitment not to use devaluation as a weapon of competitive trade policy 17 .The Bretton Wood System • US Govt.

reduce imports) (3) trade liberalization (need to export) (4) privatization (state enterprises seen to be inefficient) (5) financial deregulation (no financial repression or directed credit. market interest rates) (6) price liberalization (7) deregulation of private business (8) openness to foreign capital (direct and portfolio) 18 .Typical IMF Structure • A typical IMF menu thus looks something like this: (1) budgetary austerity (bring fiscal deficit to certain % of GDP) (2) currency devaluation (to make exports more competitive.

The Functions of the IMF  Surveillance Gathering data and assessing economic policies of countries  Technical Assistance Strengthening human skills and institutional capacity of countries  Financial Assistance Lending to countries to support reforms 19 .

not just to provide temporary financing but to support adjustment and reform policies aimed at correcting the underlying problems. in member countries and at the global level. and gives policy advice to its members based on its more than fifty years of experience.The Functions of the IMF • Monitors economic and financial developments and policies. • Provides the governments and central banks of its member countries with technical assistance and training in its areas of expertise . • Lends to member countries with balance of payments problems.

The Functions of the IMF: Surveillance Country Undertaking annual health check-ups of economies Regional Examining policies pursued under regional arrangements Global Assessing the health of the world economy World Economic Outlook Assessing the stability of international financial markets Global Financial Stability Report 21 .

regulations.The Functions of the IMF: Technical Assistance  Design and implementation of fiscal and monetary policies  Review of economic and financial legislation. and procedures  Institution and capacity building – Central banks – Treasuries – Tax and customs departments – Statistical services  Training for officials of member countries 22 .

Meets once a year.  Board of Governors: one Governor from each member country. 23 .  Day to day affairs are guided by the Executive Board: 24 Executive Directors.Governance of the IMF  IMF is accountable to its member countries. Managing Director of IMF is Chairman of the Executive Board.

The Functions of the IMF: Main Types of IMF Loans Type of Loan Stand-by Arrangement (SBA) Extended Fund Facility (EFF) Purpose Medium-term assistance for temporary BOP difficulties Longer-term assistance for longer-term BOP problems Interest Rate Basic rate Plus surcharge for heavy borrowing Basic rate Plus surcharge for heavy borrowing 0.5 % a year 24 Poverty Reduction Longer-term and Growth Facility assistance for BOP (PRGF) difficulties of a structural nature .

Total quotas amount to about US$300 billion.  A member’s quota is determined by its economic weight in the global economy.  A member’s quota determines its voting power and size of loan it can borrow. 25 .IMF Resources  IMF’s capital base consists of membership quotas. the financial contribution made by member countries.

S.Special Drawing Rights (SDR) SDRs per Currency unit (e. as reported by the issuing central bank.67734 SDR) These rates are the official rates used by the Fund to conduct operations with member countries. and the SDR value of the U. The rates are derived from the currency's representative exchange rate. Currency units per SDR (e.00 = 0.g. is the reciprocal of the SDR per currency unit rate. 26 . $ 1. which are not used in Fund transactions.47638 = 1 SDR) This rate. rounded to six significant digits. $ 1. dollar rounded to six significant digits.g.

Funding methods • Stand-By Arrangements • Extended Fund Facility • Poverty Reduction and Growth Facility • Supplemental Reserve Facility. • Emergency Assistance 27 .

Funding Facilities • Contingent Credit Lines • The Compensatory Financing facility • Emergency assistance • The Emergency Financing Mechanism • Concessional Lending facility 28 .

Collapse of fixed exchange rate system • Fixed rate system worked well till 1960 • The system collapsed in 1973 • Dollar was reference point for all currencies and any pressure on dollar devalue could wreck havoc with the system • Break up of fixed exchange could be traced with 1965-68 – Vietnam war expenses and US welfare measures of Johnson resulted in budget deficit that was not financed by tax but be increase in money supply which resulted in inflation that was less than 4% in 1966 to 9% in 1968 29 .

. worsening trade position led to speculation that dollar would be devalued • In 1971 US trade figures showed it was importing more than what it is exporting • This set off massive purchases of German mark by speculators that mark will be revalued against dollar.Collapse of fixed exchange rate system • Increase in US inflation.

Collapse of fixed exchange rate system • On May 4th . German central bank had to buy US$ 1 billion to hold dollar/DM exchange rate • May 5th May again it had to buy another US$ 1 billion in the first hour of trading • This forced the Bank to make its currency float 31 . 1971.

for the dollar to devalue it requires all other currencies to simultaneously agree to revalue their currencies for which they did not agree • They would lose out export competitiveness Vs US products .Collapse of fixed exchange rate system Difficulty to devalue US $ • Markets wanted dollar to devalue • Since dollar was a reference currency under the Bretton Woods.

US Announces to float $ • In August 1971..Finally…. dollar was devalued by 8% and import tax was removed in December 1971 33 . US President Nixon announced that dollar was no longer convertible into gold • It also announce new 10% tax on imports till its trading partners agree to revalue • With the discussions with trading partners.

and collapse of the system 34 .Prerequisites for success of the Fixed System • Two pre-requisites required for the system: – US inflation to remain low – US trade deficit under check • Any strain led to speculative attack on the dollar.

gold was abandoned as a reserve asset • IMF quotas were increased made available to 183 countries • Non-oil exporting. Jamaica Agreement. LDCs were given greater access to IMF funds 35 .Floating Rates • January 1976.

Flexible rates 1973… .

unexpected rise in dollar despite deteriorating BOP of US • 1997 The Asian Crisis 37 .Exchange Rates Since 1973 • 1971 oil crisis – OPEC raised oil prices four fold • US inflation 1977-78 • In 1979 oil prices doubled • 1980-85.

.Attributes of Ideal Exchange rate regime  Possesses three attributes. often referred to as the Impossible Trinity: – Exchange rate stability – Full financial integration – Monetary independence  The forces of economics do not allow the simultaneous achievement of all three.

The Impossibility Trinity .

Fixed Exchange Rate A nation’s choice as to which currency regime to follow reflects national priorities about all facets of the economy.  The choice between fixed and flexible rates may change over time as priorities change. – interest rate levels. – unemployment. – trade balances. including: – inflation. . and – economic growth.

a fixed rate regime has the following problems: – Need for central banks to maintain large quantities of hard currencies and gold to defend the fixed rate. – inherent anti-inflationary nature of fixed prices. However. – Fixed rates can be maintained at rates that are inconsistent with economic fundamentals .Fixed Vs Flexible Rates Countries would prefer a fixed rate regime for the following reasons: – stability in international prices.

and Singapore. dollar.Current Exchange Rate System • 36 major currencies. .S. Russia. India. adopt some forms of “Managed Floating” system. such as the U. including the China. and the British pound are determined largely by market forces. • 50 countries. the Japanese yen. the Euro.

UAE and Venezuela. but they maintain a peg to another currency such as the U. dollar. . including many islands in the Caribbean. many African nations. • The remaining countries have some mixture of fixed and floating exchange-rate regimes.Current Exchange Rate System • 41 countries do not have their own national currencies! • 40 countries. do have their own currencies.S.

 To pave the way for the European Monetary Union. . EMU (1999-): A single currency for most of the European Union.  To coordinate exchange rate policies vis-à-vis non European currencies.EMU 1979 – 1998: European Monetary System Objectives:  To establish a “zone of monetary stability” in Europe.

Ireland. Cyprus. Bulgaria.EMU 27 members of the European Union are:  Austria. Germany. Poland. . Italy. Spain. Luxembourg. Czech. Portugal. France. Hungary. Lithuania. Slovakia. Belgium. and the United Kingdom. Sweden. The Netherlands. Estonia. Romania. Denmark. Greece. Slovenia. Finland. Malta. Latvia.

Portugal. Italy. Greece. The Netherlands. Ireland. Luxembourg. Belgium. Spain. . Germany.EMU Currently. France. twelve members of the EU have their currencies pegged against the Euro (Maastricht Treaty) beginning 1/1/99:  Austria. Finland.

both inside and outside of the euro zone enjoy price transparency and increased price-based competition. exchange rate stability. financial integration ..  All consumers and businesses.  Currency risks and costs related to exchange rate uncertainty are reduced.EMU Benefits for countries using the € currency inside the Euro zone include:  Cheaper transaction costs.e. i.

EMU • Costs for countries using the € currency include: – Completely integrated and coordinated national monetary and fiscal policy rules: • Nominal inflation should be no more than 1.5% above average for the three members of the EU with lowest inflation rates during previous year. . • Long-term interest rates should be no more than 2% above average for the three members of the EU with lowest interest rates.

e..EMU • Fiscal deficit should be no more than 3% of GDP. • Government debt should be no more than 60% of GDP. • European Central Bank (ECB) was established to promote price stability within the EU. no monetary independence! . i.

Italy. Luxembourg. and Spain. Ireland.  The following countries opted out initially: – Denmark. and the U.Euro  Product of the desire to create a more integrated European economy. Netherlands. Finland. France.  Eleven European countries adopted the Euro on January 1. Greece. Belgium.  Euro notes and coins were introduced in 2002  Greece adopted the Euro in 2001  Slovenia adopted the Euro in 2007 . Germany. Sweden. Portugal.K. 1999: – Austria.

Bretton Woods • 1958 Birth of EEC • 1963 US imposed Interest equalization tax • 1963 voluntary credit restraints • 1968 Mandatory controls on foreign investments • 1970 SDRs created 51 .Chronology of events • 1944.

5%) • 1973 US $ devalued from 38 to 42.25%) with a tunnel (4.Chronology of events • 1971 US abandoned US$ gold convertibility (35 to 38) • A snake (2.22 • 1974 Oil price crisis • 1976 Jamaica Agreement • 1978 EMS replaced with joint currency 52 .

Chronology of events • 1980 LA debt crisis • 1985 Group of 5 countries Plaza Agreement • 1987 Louvre Accord • 1992 Tight monetary Policy in Germany – UK withdrawn) • 1993 Allowable deviation band around EMS 15% 53 .

sub prime crisis • 2011-12 – euro debt crisis 54 .Chronology of events • 1993 EEC changed to EU • 1994 Mexican Peso crisis • 1997 Asian crisis • 1999 Euro Jan 1 • 2002 Euro coins introduction • 2008 US .

Current Scenario • Conventional Fixed peg arrangements • Pegged Exchange Rates with Horizontal Bands • Crawling Peg • Crawling bands • Managed Floating with no pre-announced path for exchange rate • Independently Floating 55 .

Evolving Role of the IMF • Streamlining conditionality and building ownership • Promoting transparency of IMF members’ policies and accountability • Making the IMF more transparent • Assessing the IMF’s work—the Independent Evaluation Office • Listening and learning 56 .

Summary • Exchange rate systems • IMF • Role and funding facilities • Tackling current global crisis 57 .