Chapter

11

The International
Monetary System
 Learning Objectives
v 11-1 Describe the historical development of the modern
global monetary system.
v 11-2 Explain the role played by the World Bank and the
IMF in the international monetary system.
v 11-3 Compare and contrast the differences between a
fixed and a floating exchange rate system.
v 11-4 Identify exchange rate regimes used in the world
today and why countries adopt different exchange rate regimes.
v 11-5 Understand the debate surrounding the role of the
IMF in the management of financial crises.
v 11-6 Explain the implications of the global monetary
system for management practice.
 1. Introduction
vThe international monetary system refers
to the institutional arrangements that
countries adopt to govern exchange rates
• Floating exchange rate regime.
vWhen the foreign exchange market
determines the relative value of a currency.
vPegged exchange rate.
vThe value of the currency is fixed relative to
a reference currency, such as the U.S. dollar.

10-3
 Introduction 2

International Monetary System continued

vManaged float system.

vThe value of the currency is determined by market forces but
managed by the government.
vAlso called a dirty-float system.
vFixed exchange rate.
vValues of a set of currencies are fixed against each other at a
mutually agreed-on exchange rate.
vEuropean Monetary System collapsed in 1973.

vDollarization.
vAbandon current currency and adopt another
currency.
Checking your knowledge

5-5
The institutional arrangement that
governs exchange rates is known
as
v
the:

vA. financial control system.

B. international monetary system.
C. international monetary fund.
D. international financial regime.

10-6
vWhen the foreign exchange market
determines the relative value of a currency,
we say that the currency is adhering to
a(n):

vA. volatile exchange rate.

B. pegged exchange rate.
C. floating exchange rate.
D. fixed exchange rate.

10-7
A _____ means the value of the
currency is fixed relative to a
reference currency.
vA. pegged exchange rate
B. dynamic exchange rate
C. floating exchange rate
D. fixed exchange rate

10-8
vWhen the central bank of a country
intervenes in the foreign exchange market
to try to maintain the value of its currency if
it depreciates too rapidly against an
important reference currency, the country
is said to be following a _____ system.

vA. fixed exchange rate

B. clean float
C. floating exchange rate
D. dirty float
10-9
vIn a _____ exchange rate system, the value of
a set of currencies is fixed against each
other at some mutually agreed on exchange
rate.

vA. pegged
B. dirty
C. fixed
D. direct

10-10
What Was The Gold Standard?
vThe gold standard refers to a system in which
countries peg currencies to gold and guarantee
their convertibility
vthe gold standard dates back to ancient times when
gold coins were a medium of exchange, unit of account,
and store of value
vpayment for imports was made in gold or silver
vlater, payment was made in paper currency which was
linked to gold at a fixed rate
vin the 1880s, most nations followed the gold standard
v$1 = 23.22 grains of “fine” (pure) gold
vthe gold par value refers to the amount of a currency
needed to purchase one ounce of gold

10-11
vThe gold standard had its origin in the use
of _____ as a medium of exchange, unit
of account, and store of value.

vA. the U.S. dollar

B. the British pound
C. paper currency
D. gold coins

10-12
vWhen a country pegs its currencies to gold
and guarantees convertibility, the country is
following the:

vA. gold standard.

B. Bretton Woods system.
C. fixed exchange system.
D. floating exchange rate system.

10-13
vUnder the gold standard, the U.S. dollar
could be converted into _____ grains of fine
gold.

vA. 10.1
B. 17.3
C. 23.33
D. 480

10-14
vThe amount of a currency need to purchase
one ounce of gold under the gold standard
was known as the:

vA. gold par value.

B. gold standard.
C. fixed gold rate.
D. pegged rate.

10-15
 2. The Gold Standard 1

vMechanics of the Gold Standard

vPegging currencies to gold and
guaranteeing convertibility.
vMost major trading nations adopted the
gold standard by 1880.
vGold par value is the amount of currency
needed to purchase one ounce of gold.
 The Gold Standard 2

vStrength of the Gold Standard

vBalance-of-trade equilibrium:
vReached when the income a nation’s
residents earn from exports equals the
money paid for imports.
vSome believe the world should return
to the gold standard.
 The Gold Standard 3

vThe Period between the Wars: 1918 to

1939
vGold standard abandoned in 1914.
vThe U.S., Great Britain, and France
returned to it in 1919, 1925, and 1928
respectively, but left again.
vBy the start of World War II in 1939, the
gold standard was dead.
Checking your knowledge

5-19
vThe great strength claimed for the gold
standard was that it contained a powerful
mechanism for achieving _____ by all
countries.

vA. balance-of-trade equilibrium

B. economic stability
C. interest rate parity
D. equal tariff levels

10-20
vWhen the income a country's residents earn
from exports is equal to the money its
residents pay to other countries for imports,
the country is said to:

vA. be in current account equilibrium.

B. be in capital account equilibrium.
C. be in balance-of-trade equilibrium.
D. have a managed float.

10-21
 3.The Bretton Woods System 1

vBretton Woods, New Hampshire (1944)

established two multinational institutions.
1. International Monetary Fund (IMF):
vTasked with maintaining order in the international
monetary system.
vSystem of fixed exchange rates would be policed by
the IMF.
2. World Bank:
vTo promote general economic development.
vCommitment not to use devaluation as a weapon
of competitive trade policy.
 The Bretton Woods System 2

vThe Role of the IMF

vDiscipline:
vMaintaining a fixed rate brings stability.
vFixed rate imposes monetary discipline on countries,
curtailing inflation.
vFlexibility:
vIMF lending facilities.
vAdjustable parities.
 The Bretton Woods System 3

vThe Role of the World Bank

vInitially established to help reconstruct the war-
torn economies of Europe.
vLater, moved to lending to third-world nations
for development.
vLends money two ways:
1. By raising money through bond sales.
2. Through subscriptions from wealthy members.
Checking your knowledge

5-25
vBretton Woods set a restriction of _____
percent for devaluations of currency, if a
currency became too weak to defend,
without permission from the IMF.

vA. 5
B. 10
C. 15
D. 20
v

10-26
vUnder the Bretton Woods, all countries
fixed the value of their currency in terms of:

vA. the British pound.

B. the euro.
C. the U.S. dollar.
D. gold.

10-27
vThe Bretton Woods IMF Articles of
Agreement, tried to impose discipline by
adopting a _____ exchange rate system that
was seen as a mechanism for controlling
inflation and imposing economic discipline
on countries.

vA. fixed
B. floating
C. dirty float
D. pegged
10-28
The Bretton Woods agreement differed
from the gold standard in that it:
v
A. incorporated both discipline and
flexibility.
B. was a floating rate system.
C. was based on the British pound.
D. was a rigid system of fixed exchange
rates.

10-29
The International bank for Reconstruction
and Development is also known as the:

vA. IMF.
B. World Bank.
C. European Central Bank.
D. International Development Agency.

10-30
4. The Collapse of the Fixed Exchange Rate
System
vBretton Woods system collapsed in 1973.
vManaged-float system now in place.
vTraced breakup of fixed exchange rate system to
U.S. macroeconomic policy package of 1965 to
1968.
vSpeculation that dollar would be devalued.
vNixon announced dollar no longer convertible into
gold.
vBretton Woods could not work if the dollar was under
speculative attack.
Figure 11.1 Major currencies dollar
index, 1973 to 2019

v Access the text alternative for slide

images

v Source: Data from www.federalreserve.gov.

Checking your knowledge

5-33
vMost economists trace the breakup of the
Bretton Woods fixed exchange rate system,
in 1973, to the:

vA. rise of communism in Eastern Europe.

B. economic integration movement
sweeping Western Europe.
C. macroeconomic policy package in the U.S.
during 1965 to 1968.
D. increase in inflation and the worsening of
the British foreign trade position.
10-34
The Bretton Woods Agreement
could only work if the U.S. had:
v
A. high inflation and no balance-of-
payments deficit.
B. low inflation and no balance-of-payments
deficit.
C. low inflation and a current account
deficit.
D. high inflation and a capital account
surplus.
10-35
5. The Floating Exchange Rate Regime 1

vThe Jamaica Agreement

vFloating rates were declared
acceptable.
vGold was abandoned as a reserve
asset.
vTotal annual IMF quotas were
increased to $41 billion.
The Floating Exchange Rate Regime 2

vExchange Rates Since 1973

vExchange rates have become much more volatile
and less predictable.
vValue of dollar has fluctuated.
vLouvre Accord in 1987 pledged to support the
stability of exchange rates around their
current levels through government
intervention.
vBoth market forces and government
intervention have determined the value of the
dollar.
Figure 11.1 Major currencies dollar
index, 1973 to 2019

v Access the text alternative for slide

images

v Source: Data from www.federalreserve.gov.

Checking your knowledge

5-39
vIn 1976, the _____ formalized the floating
exchange rate system that followed the
collapse of fixed exchange rate system.

vA. gold standard

B. Plaza Accord
C. Jamaica Agreement
D. Louvre Accord

10-40
vThe main elements of the 1976 Jamaica
agreement include all of the following
except:

vA. floating rates were declared

unacceptable.
B. gold was abandoned as a reserve asset.
C. total annual IMF quotas were increased to
$41 billion.
D. IMF members were permitted to sell
their own gold reserves at the market price.

10-41
vThe _____ suggested that it would be
desirable for most major currencies to
appreciate relative to the dollar, and
signatories pledged to intervene in the
foreign exchange markets, selling dollars, to
achieve this objective.

vA. Louvre Accord

B. Plaza Accord
C. Bretton Woods Agreement
D. gold standard
10-42
vUnder the _____ of 1987, the Group of Five
agreed that exchange rates had realigned
sufficiently from earlier levels and pledged
to support the stability of exchange rates
around their current levels by intervening
in the foreign exchange market when
necessary.
A. Plaza Accord
B. Jamaica Agreement
C. Louvre Accord
D. Bretton Woods Agreement

10-43
 6. Fixed versus Floating Exchange Rates 1

vThe Case for Floating Exchange Rates

vMonetary Policy Autonomy.
vTo maintain parity under a fixed system, countries
were limited in their ability to use monetary policy to
expand or contract economies.
vTrade Balance Adjustments.
vUnder Bretton Woods, countries with permanent
deficits in balance of trade could not be corrected by
domestic policy.
vCrisis Recovery.
vFloating exchange rate advocates, believe exchange
rate adjustments can help a country deal with
economic crises.
Fixed versus Floating Exchange Rates 2

vThe Case for Fixed Exchange Rates

vMonetary Discipline.
vGuarantees governments do not expand money supply
at inflationary rates.
vSpeculation.
vCan cause fluctuations in exchange rates.
vUncertainty.
vAdds to uncertainty surrounding future currency
movements.
Fixed versus Floating Exchange Rates 3

vThe Case for Fixed Exchange Rates continued

vTrade Balance Adjustments and Economic Recovery.

vCritics say trade deficits determined by balance
between savings and investment in a country, not by
the external value of currency.
v Depreciation in currency will lead to inflation.

vWho is Right?
vEconomists cannot agree.
Checking your knowledge

5-47
A managed-float system is also
known as a:
v
A. fixed exchange rate system.
B. floating exchange rate system.
C. pegged exchange rate system.
D. dirty-float exchange rate system.

10-48
vAccording to some analysts, under a _____
regime, countries are limited in their ability
to use monetary policy to expand or
contract their economies by the need to
maintain exchange rate parity.

vA. managed float

B. dirty float
C. fixed exchange rate
D. floating exchange rate

10-49
 A fixed exchange rate regime:
v A. modeled along the lines of the Bretton Woods
system will not work.
B. allows each country to choose its own inflation
rate.
C. is characterized by speculation that adds to the
uncertainty surrounding future currency
movements.
D. leads to a situation where governments under
political pressures expand monetary supply too
rapidly, causing unacceptably high price inflation.

10-50
7. Exchange Rate Regimes in Practice 1

vPegged Exchange Rates

vCountry will peg value of its currency to
that of a major currency.
vPopular among many of the world’s
smaller nations.
vImposes monetary discipline on country
and leads to low inflation.
 Exchange Rate Regimes in Practice 2

vCurrency Boards
vBoard commits itself to converting its
domestic currency on demand into another
currency at fixed exchange rate.
vHolds reserves of foreign currency equal at
fixed exchange rate to at least 100 percent
of domestic currency issued.
vCan issue additional domestic notes and
coins only when there are foreign exchange
reserves to back it.
Checking your knowledge

5-53
v In 2007, about a quarter of the IMF
members had a(n) _____ exchange rate
policy.

vA. fixed peg

B. currency board
C. free float
D. adjustable peg

10-54
v In 2007, about a quarter of the IMF
members had a(n) _____ exchange rate
policy.

vA. fixed peg

B. currency board
C. free float
D. adjustable peg

10-55
vUnder a pegged exchange rate regime, a
country will peg the value of its currency to
_____ so that its own currency rises too.

vA. its domestic inflation rate

B. that of a major currency
C. its interest rates
D. its foreign exchange reserves

10-56
Pegged exchange rates are popular
among many of the world's:
v
A. highly developed nations.
B. richest nations.
C. smaller nations.
D. large economies.

10-57
The great virtue claimed for a
pegged exchange rate is that it:
v
A. imposes monetary discipline on a
country.
B. leads to high inflation.
C. leads to devaluation.
D. increases fluctuations in exchange rates.

10-58
Under a strict currency board
system, interest rates:
v
A. adjust automatically.
B. are constant.
C. decline consistently.
D. rarely move.

10-59
 What Is A Currency Board?
vCountries using a currency board commit
to converting their domestic currency on
demand into another currency at a fixed
exchange rate
vthe currency board holds reserves of foreign
currency equal at the fixed exchange rate to at
least 100% of the domestic currency issued
vthe currency board can issue additional
domestic notes and coins only when there are
foreign exchange reserves to back them

10-60
vWhen a country commits itself to
converting its domestic currency on
demand into another currency at a fixed
exchange rate, the country has adopted a
_____ system of exchange rates.

vA. pegged
B. floating
C. currency board
D. fixed

10-61
 8. Crisis Management by the IMF 3

vFinancial Crises in the Post–Bretton

Woods Era continued

vCauses:
vHigh relative price inflation rates.
vWidening current account deficit.
vExcessive expansion of domestic borrowing.
vHigh government deficits.
vAsset price inflation.
 Crisis Management by the IMF 4

vEvaluating the IMF’s Policy Prescriptions

vInappropriate Policies.
vOne size fits all.
vMoral Hazard.
vPeople behave recklessly because they know they will
be saved if things go wrong.
vLack of Accountability.
vLack real mechanism for accountability.
vSachs says IMF lacks expertise required to do a good
job.
 Crisis Management by the IMF 5

vEvaluating the IMF’s Policy Prescriptions continued

vObservations.
vThere are cases where one can argue that IMF policies
had been counterproductive or only had limited
success.
vCan also point to notable accomplishments.
vThe IMF started to change its policies in response to
2008 to 2009 global financial crisis.
Checking your knowledge

5-65
vWhen a speculative attack on the exchange
value of a currency results in a sharp
depreciation in the value of a currency, a(n)
_____ has occurred.

vA. foreign debt crisis

B. banking crisis
C. currency crisis
D. exchange crisis

10-66
 A banking crisis:
vA. is a situation in which consumer spending
patterns significantly affect a country's balance of
payments, thereby affecting its currency.
B. is a situation in which a country cannot service
its debt obligations.
C. refers to a loss of confidence in the banking
system that leads to a run on banks, as individuals
withdraw their deposits.
D. occurs when a speculative attack on the
exchange value of a currency results in a sharp
depreciation in the value of the currency.
10-67
 A foreign debt crisis:
vA. is a situation in which consumer spending
patterns significantly affect a country's balance of
payments, thereby affecting its currency.
B. is a situation in which a country cannot service
its debt obligations.
C. refers to a loss of confidence in the banking
system that leads to a run on banks, as individuals
withdraw their deposits.
D. occurs when a speculative attack on the
exchange value of a currency results in a sharp
depreciation in the value of the currency.
10-68
 9. What Was The Mexican
Currency Crisis Of 1995?
vThe Mexican currency crisis of 1995 was a
result of
vhigh Mexican debts
va pegged exchange rate that did not allow for a
natural adjustment of prices
vTo keep Mexico from defaulting on its debt,
the IMF created a $50 billion aid package
vrequired tight monetary policy and cuts in
public spending

10-69
 What Was The
Asian Currency Crisis?
v The 1997 Southeast Asian financial crisis was
caused by events that took place in the previous
decade including
1. An investment boom - fueled by huge increases in
exports
2. Excess capacity - investments were based on
projections of future demand conditions
3. High debt - investments were supported by dollar-
based debts
4. Expanding imports – caused current account deficits

10-70
 What Was The
Asian Currency Crisis?
vBy mid-1997, several key Thai financial
institutions were on the verge of default
vspeculation against the baht
vThailand abandoned the baht peg and allowed the
currency to float
vThe IMF provided a $17 billion bailout loan
package
vrequired higher taxes, public spending cuts,
privatization of state-owned businesses, and higher
interest rates

10-71
 What Was The
Asian Currency Crisis?
v Speculation caused other Asian currencies including the
Malaysian Ringgit, the Indonesian Rupaih and the
Singapore Dollar to fall
v These devaluations were mainly driven by
v excess investment, high borrowings, much of it in dollar
denominated debt, and a deteriorating balance of payments
position
v The IMF provided a $37 billion aid package for Indonesia
v required public spending cuts, closure of troubled banks, a
balanced budget, and an end to crony capitalism
v The IMF provided a $55 billion aid package to South Korea
v required a more open banking system and economy, and restraint
by chaebol

10-72
Checking your knowledge

5-73
vThe 1995 Mexican currency crisis and the
1997 Asian financial crisis were the result of
all of the following except:

vA. excessive foreign borrowings.

B. a weak or poorly regulated banking
system.
C. high inflation rates.
D. high balance-of-trade surplus.
v

10-74
vIn 1997, the IMF agreed to provide the Thai
government with $17.2 billion in loans to
help its shattered economy. While doing so,
IMF imposed all of the following restrictions
except:

vA. the government was to increase taxes.

B. public spending needed to be cut.
C. several state-owned businesses were to
be privatized.
D. interest rates were to be reduced.
10-75
 10. Focus on Managerial Implications 1

vCurrency Management, Business Strategy,

and Government Relations
vCurrency Management:
vCombination of government intervention and
speculative activity drives the foreign exchange
market.
vCompanies need to be aware of this and adjust their
foreign exchange transactions accordingly.
 Focus on Managerial Implications 2

vCurrency Management, Business Strategy,

and Government Relations continued

vBusiness Strategy:
vCompanies should pursue strategies that will increase
their strategic flexibility in the face of unpredictable
exchange rate movements.
vFlexibility comes in the form of dispersing production
to different locations around the globe to hedge
against fluctuations.
vCompanies can reduce exposure by contracting out
manufacturing.
 Focus on Managerial Implications 3

vCurrency Management, Business Strategy,

and Government Relations continued

vCorporate-Government:
vBusiness can influence government policy toward the
international monetary system.
vInternational business should promote an
international monetary system that minimizes volatile
exchange rate movements, particularly when those
movements are unrelated to long-run economic
fundamentals.
 Q/A

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