The international monetary

system

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 The role of the IMF in the global economic
crisis
IMF has played a key role in the global economic
crisis.
In the Eurozone alone it has aided the economies
of Greece, Ireland and Portugal.
The IMF is a global institution set up after the
second World War to promote international
monetary cooperation and exchange rate
stability.

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• It has over 180 member countries.
• It has a pool of funds it draws upon to support
nations in distress.
• Each country provides funds to the IMF in
proportion to the size of its economy.
• Countries receiving financial support must
follow IMF policy prescriptions in return for
loans.

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• IMF assists countries suffering from banking
crisis, currency crisis, and debt crisis.
• In 2008 the world financial system entered
into a period of severe financial instability.

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• What began as a crisis in the US housing
market spread to banks across the developed
world.
• House prices falling and loan defaults rising ,
banks stopped lending and households
stopped spending .

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• Economies across the developed world went
into a severe depression.
• As govts. Step in to prop up their dwindling
economies, budget deficits significantly
widened.
• By 2010 the state of public finances in many
countries had caused serious concerns in the
financial markets.

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• Some peripheral eurozone governments were
priced out of the market, and had to apply to
the IMF for emergency funding.
• By end of 2011 the Eurozone was fighting for
survival in the wake of an acute sovereign
debt crisis.

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• Stability in the international monetary system
depends to a large extent on confidence in
global financial markets.
• If financial institutions loose faith in the ability
or willingness of debtors to repay their loans,
they withdraw funding and capital without
delay.

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• The withdrawal can destabilize the global
financial system,
• The IMF role is to step in and support
countries to restore and maintain confidence
in the system on which international business
depends.

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• In 2010 the EU and IMF agreed to provide
Greece with 110 billion of loans to help the
economy from collapse.

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• The Greek economy went through turmoil
after years of declining competitiveness and
productivity and lack of reform.
• Receiving the full package of loans was
conditional on Greece pushing through
parliament severe austerity measures, to cut
its deficit and debt levels.

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• Also it had to implement structural reforms to
revive the economy.
• In 2011 EU and Greece agreed on another 130
billion additional bail out for Greece.
• In 2010 Ireland got 85 billion pounds rescue
package to deal with its banking and housing
market crisis.

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• In 2011 Portugal got 78 billion EU IMF rescue
package
• The IMF role in the International monetary
system is profound,

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• It has provided support to Asian economies
during the Asian financial crisis of the 1990s.

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 The Gold standard
• When gold was the standard used as a
medium of exchange.
• This was adopted by major trading nations like
Great Britain, Germany, Japan and US.

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• The determination of exchange rate was easy
to get. For example under the gold standard,
one US dollar was defined as equivalent to
23.22 grains of pure fine gold.

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• In theory one could demand that the US
government convert that one dollar into 23.22
grains of gold. Since there are 480 grains in an
ounce one ounce cost $20.67(480/23.22)

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• The gold standard worked well from 1870s
until the start of World War 1 in 1914 when it
was abandoned.
• During the war most gvts financed the war
through printing money. This created inflation.

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 Bretton W
• In 1944 at the height of the World war 2, 44
countries met at Bretton Woods, New
Hampshire to design new international
monetary system.
• There was consensus that fixed exchange
rates were desirable

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• The agreement reached at Bretton Woods
established the IMF and World Bank.
• The task of the IMF was to maintain order in
the international monetary system.
• The World Bank was to promote general
economic development.

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• The Bretton Woods agreement also called for
a fixed exchange rate that would be pliced by
the IMF.
• All countries were to fix the value of their
currency to gold but were not required to
exchange their currencies for gold.

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 The Role of IMF

• A fixed exchange rate regime imposes

discipline in that it puts a brake on
competitive devaluations and bring stability to
the world trade environment.

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• It also imposes monetary discipline on
countries thereby curtailing price inflation.

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• It was recognized that fixed exchange rate
regime would be inflexible and was bound to
break down just like the gold standard
system.

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• In some cases a country’s attempt to reduce
its money supply growth and correct
persistent balance of payment deficit could
force a country into recession and create high
unemployment.

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 Archtects of
• Architects of Bretton Woods wanted to avoid
high unemployment.
• So IMF was ready to lend to countries during
short periods of balance of payments deficit.
• A pool of Gold reserves contributed by IMF
members provided for the lending resources.

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• Countries were allowed to borrow limited
from IMF without stringent measures taken
• For large amounts there was need for
stringent measures and supervision by IMF
• Heavy borrowers must agree to monetary and
fiscal conditions.

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• These include IMF mandated targets on
domestic money supply growth, exchange rate
policy, tax policy government spending

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 Role of world bank

• Official name of the World Bank is the

International Bank for reconstruction and
Development(IBRD).
• When Bretton Woods met the need to
reconstruct the war torn economies of Europe
was foremost.

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• This role was then taken over by the Marshal
Plan under which US lend money directly to
the affected nations.
• The world bank than turned its attention to
the development of third world countries.

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• In the 1950 it concentrated in public sector
projects.
• Such as power stations, roads

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• In the 1960s it began to lend heavily in
agriculture, education, population control and
urban development

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Collapse of the Fixed Exchange rate system

• The system of fixed exchange rate established

by the Bretton Woods showed signs of strain
in the 1960s. It collapsed in 1973.

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• Then came the managed float system.

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The floating exchange rate system
• Advantages and disadvantages

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 Crisis Management by IMF
• The IMF’s original role was to provide a pool
of money from which members could borrow
short term to adjust their balance of payment
position and maintain their exchange rate.

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• A trade deficit would presumably lead to a
decline in a country’s exchange rate which
would help reduce imports and boost exports.
• No temporary IMF money would be needed.

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• Most industrialised countries tended to let the
foreign exchange market determine exchange
rates in response to demand and supply.

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• No major industrialised country has borrowed
money from IMF since 1970s.
• In 2010 IMF had 187 members
• In 2009 major IMF members increased
resources from 250 billion to 750 billion

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• The IMF has repeatedly lent money to nationa
experiencing financial crisis, requesting in
return that gvts enact certain macroeconomic
policies.

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• Critics of the IMF claim that these policies
have not always been as beneficial as the IMF
might have hoped and in some cases may
have made things worse.

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Evaluating the IMF’S Policy prescriptions

• By 2010 IMF was committing loans to some 68

countries that were struggling with economic
and/or currency crisis.
• All IMF packages come with conditions
attached

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• It has insisted on a combination of tight
macroeconomic policies including cuts in
public spending, higher interest rates and tight
monetary policy

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• It has also pushed for deregulation of formerly
protected from domestic and foreign
completion, privatisation of state owned
assets and better financial reporting from the
banking sector.

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• The policies are meant to cool overheated
economies by reigning in inflation and
reducing government spending and debt.

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• These approaches have been heavily criticised
and IMF has started to change its approach.

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• One criticsim is that IMF policiesa are one size
fit all type of approach

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• Second criticism is that rescue efforts by IMF
exacerbate moral hazard. People behave
recklessly because they know they will be
saved.

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• The other argument is that IMF has become
too powerful for an institution that lacks any
real mechanism for accountability

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• Why did the Gold standard collapse? Is there a
case for returning to some type of gold
standard? What is it?
• What opportunities might current IMF lending
policies to developing countries create for
international businesses? What threats might
they create?

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• Do you think the standard IMF prescriptions of
tight monetary policy and reduced
government spending are always appropriate
for developing nations experiencing currency
crisis? How might the IMF change its
approach? What would the implications be for
international businesses?

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