International Monetary

Fund
Topics

Historical perspective on exchange rate

• Gold Standard

• International Monetary Fund

• Exchange Rate Regimes – Fixed and Fluctuating

• Euro and its evolution and current challenges

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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.

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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

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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

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Gold Standard

• Pegging currencies to gold and guaranteeing convertibility is

known as the Gold Standard.
• By 1880, GB, Germany, Japan and US had adopted Gold
Standard
• Value of currency was determined with respect to the gold
• For instance, US dollar was defined as 23.22 gms of fine pure
gold
• Since 480 grains in an ounce, one ounce of gold cost was
$20.67(480/23.22)

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Gold Standard

• The amount of currency required to buy one ounce of gold

was referred to as gold par value.
• 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 = $4.87 (20.67/4.25)
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, 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, and this increased price levels in US GB,
France
• US returned to gold std in 1919, GB in 1925 and France in
1928
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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.
• US followed suit in 1933 but returned to Gold Std in 1934
by raising dollar price of gold from $20.67 per ounce to $35
per ounce.
• This effectively is devaluation of dollar
• Pound was $4.87 and became $8.24

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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
IMF - constituted

• The International Monetary Fund—also known as the “IMF”

or the “Fund”
• —was conceived at a United Nations conference convened in
Bretton Woods, New Hampshire, U.S. in July 1944.
• 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.

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IMF - History and Background
• Agreement for its creation came at the United Nations-
sponsored Monetary and Financial Conference in Bretton
Woods, New Hampshire, United States, on July 22, 1944.

• 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, Harry Dexter White.

• The Articles of the IMF Agreement came into force on

December 27, 1945, the organization came into existence in
May 1946, as part of a post-WWII reconstruction plan, and it
began financial operations on March 1, 1947.

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History and Background

• It is sometimes referred to as a “Bretton Woods institution",

along with the Bank for International Settlements (BIS) and
the World Bank, its twin organization.

• Together, these three institutions define the monetary policy

shared by almost all countries with market economies. In
order to gain access to IMF loans, BIS privilege, and strategic
World Bank development loans, a country must normally
agree to terms set forth by all three organizations.

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The IMF describes itself as:

“An organization of 184 countries, working to foster global

monetary cooperation, secure financial stability, facilitate
international trade, promote high employment and
sustainable economic growth, and reduce poverty”.

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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

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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.
The Bretton Wood System

• US Govt. – 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

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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;
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)
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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
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The Functions of the IMF

• Monitors economic and financial developments and policies,

in member countries and at the global level, and gives policy
advice to its members based on its more than fifty years of
experience.

• Lends to member countries with balance of payments

problems, not just to provide temporary financing but to
support adjustment and reform policies aimed at correcting
the underlying problems.

• Provides the governments and central banks of its member

countries with technical assistance and training in its areas of
expertise
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
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The Functions of the IMF:
Technical Assistance

▪ Design and implementation of fiscal and monetary policies

▪ Review of economic and financial legislation, regulations,
and procedures
▪ Institution and capacity building
– Central banks
– Treasuries
– Tax and customs departments
– Statistical services
▪ Training for officials of member countries

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Governance of the IMF

▪ IMF is accountable to its member countries.

▪ Board of Governors: one Governor from each member

country. Meets once a year.

▪ Day to day affairs are guided by the Executive Board: 24

Executive Directors. Managing Director of IMF is Chairman of
the Executive Board.

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The Functions of the IMF:
Main Types of IMF Loans

Type of Loan Purpose Interest Rate

Stand-by Medium-term Basic rate
Arrangement assistance for Plus surcharge for
(SBA) temporary BOP heavy borrowing
difficulties
Extended Fund Longer-term Basic rate
Facility (EFF) assistance for Plus surcharge for
longer-term BOP heavy borrowing
problems
Poverty Reduction Longer-term 0.5 % a year
and Growth Facility assistance for BOP
(PRGF) difficulties of a
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structural nature
IMF Resources

▪ IMF’s capital base consists of membership quotas, the

financial contribution made by member countries. 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.

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Special Drawing Rights (SDR)

SDRs per Currency unit (e.g. $ 1.00 = 0.67734 SDR)

These rates are the official rates used by the Fund to conduct
operations with member countries. The rates are derived
from the currency's representative exchange rate, as reported
by the issuing central bank, and the SDR value of the U.S.
dollar rounded to six significant digits.
Currency units per SDR (e.g. $ 1.47638 = 1 SDR)
This rate, which are not used in Fund transactions, is the
reciprocal of the SDR per currency unit rate, rounded to six
significant digits.

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Funding methods

• Stand-By Arrangements

• Extended Fund Facility

• Poverty Reduction and Growth Facility

• Supplemental Reserve Facility.

• Emergency Assistance

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Funding Facilities

• Contingent Credit Lines

• The Compensatory Financing facility

• Emergency assistance

• The Emergency Financing Mechanism

• Concessional Lending facility

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 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

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Collapse of fixed exchange rate system

• Increase in US inflation, 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

• On May 4th , 1971, 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

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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, 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

Finally…..US Announces to float $

• In August 1971, 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, dollar was

devalued by 8% and import tax was removed in December
1971

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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; and collapse

of the system

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Floating Rates

• January 1976, Jamaica Agreement, gold was abandoned as a

reserve asset

• IMF quotas were increased made available to 183 countries

• Non-oil exporting, LDCs were given greater access to IMF

funds

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Flexible rates 1973…
Exchange Rates Since 1973

• 1971 oil crisis – OPEC raised oil prices four fold

• US inflation 1977-78

• In 1979 oil prices doubled

• 1980-85, unexpected rise in dollar despite deteriorating BOP

of US

• 1997 The Asian Crisis

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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, including:
– inflation,
– unemployment,
– interest rate levels,
– trade balances, and
– economic growth.
❖ The choice between fixed and flexible rates may change over
time as priorities change.
Fixed Vs Flexible Rates

Countries would prefer a fixed rate regime for the following

reasons:
– stability in international prices.
– inherent anti-inflationary nature of fixed prices.

However, 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.
– Fixed rates can be maintained at rates that are inconsistent
with economic fundamentals
Current Exchange Rate System

• 36 major currencies, such as the U.S. dollar, the Japanese yen,

the Euro, and the British pound are determined largely by
market forces.

• 50 countries, including the China, India, Russia, and

Singapore, adopt some forms of “Managed Floating” system.
Current Exchange Rate System

• 41 countries do not have their own national currencies!

• 40 countries, including many islands in the Caribbean, many
African nations, UAE and Venezuela, do have their own
currencies, but they maintain a peg to another currency such
as the U.S. dollar.
• The remaining countries have some mixture of fixed and
floating exchange-rate regimes.
EMU

1979 – 1998: European Monetary System

Objectives:
➢ To establish a “zone of monetary stability” in Europe.
➢ To coordinate exchange rate policies vis-à-vis non
European currencies.
➢ To pave the way for the European Monetary Union.

EMU (1999-): A single currency for most of the European Union.

EMU

27 members of the European Union are:

➢ Austria, Belgium, Bulgaria, Czech, Cyprus, Denmark,
Estonia, Finland, France, Germany, Greece, Hungary,
Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, The
Netherlands, Poland, Portugal, Romania, Slovakia,
Slovenia, Spain, Sweden, and the United Kingdom.
EMU

Currently, twelve members of the EU have their currencies

pegged against the Euro (Maastricht Treaty) beginning
1/1/99:
➢ Austria, Belgium, Finland, France, Germany, Greece,
Ireland, Italy, Luxembourg, The Netherlands, Portugal,
Spain.
EMU

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

i.e., exchange rate stability, financial integration

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.
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.
i.e., no monetary independence!
Euro

 Product of the desire to create a more integrated European

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

• 1944- 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

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Chronology of events

• 1971 US abandoned US$ gold convertibility (35 to 38)

• A snake (2.25%) with a tunnel (4.5%)

• 1973 US $ devalued from 38 to 42.22

• 1974 Oil price crisis

• 1976 Jamaica Agreement

• 1978 EMS replaced with joint currency

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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%

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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 - sub prime crisis
• 2011-12 – euro debt crisis
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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
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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

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Summary

• Exchange rate systems

• IMF

• Role and funding facilities

• Tackling current global crisis

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