Development of Today’s International Monetary System

2. Development of Today’s International

Monetary System

• The IMF oversees the international monetary

system and its functions are as follows:

– To promote international monetary cooperation

– To facilitate the expansion and balanced growth of

international trade

– To promote exchange stability and to maintain orderly

exchange arrangements

– To assist in the establishment of a multilateral system

of payments in respect to current transactions

between member nations; to eliminate foreign

exchange restrictions

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Exhibit 3-1: Foreign Exchange Rate

Fluctuations over the Past 30+ Years



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2. Development of Today’s International

Monetary System

– To make available the general resources of the fund

temporarily available to members under adequate

safeguards; help members to correct maladjustments

in the balance of payments

– To shorten the duration and lessen the degree of

disequilibrium in the international balance of

payments to members

– The IMF created special drawing rights (SDRs) in

1969.



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2. Development of Today’s International

Monetary System

• The value of SDRs is determined by a weighted

average of a basket of four currencies: the U.S.

dollar, Japanese yen, European Union’s euro, and

the British pound.

• After the 1997-98 Asian financial crisis, the IMF has

worked on policies to overcome or even prevent

future crises.

• Another creation of the Bretton Woods Agreement

was the International Bank for Reconstruction

and Development (World Bank), supporting

economic development and poverty reduction.

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2. Development of Today’s International

Monetary System

• Two kinds of currency floats encompass free (clean)

float (allows no government intervention) and

managed (dirty) float (allows limited government

intervention).

• In March 1973, the major currencies began to float

in the foreign exchange markets.

• Today, the global economy is dominated by three

major currency blocs: The U.S. dollar, the EU’s euro,

the British pound, the Chinese yuan, and the

Japanese yen.

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3. Foreign Exchange and Foreign

Exchange Rates

• One of the most fundamental determinants of the

exchange rate is purchasing power parity (PPP).

• Formula for PPP:



Rt = R0



(1 + Infleuro)

* _____________

(1 + InflU.S.)



Where



R=



the exchange rate quoted in euro/$,



Infl = inflation rate,

t=

time period.

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3. Foreign Exchange and Foreign

Exchange Rates

•



Factors influencing Foreign Exchange Rates:

–



–

–



•



Macroeconomic Factors: Relative inflation,

balance of payments, foreign exchange reserves,

economic growth, government spending, money

supply growth, and interest rate policy.

Political Factors: Exchange rate control, election

year or leadership change.

Random Factors: Unexpected and/or unpredicted

events, fear of uncertainty, etc.



Many countries attempt to maintain a lower value

for their currency in order to encourage exports.



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3. Foreign Exchange and Foreign

Exchange Rates

• Spot versus forward foreign exchange

• Hard currencies are the world’s strongest and

represent the world’s leading economies.

• To avoid the risk of currency fluctuations, companies

use hedging.

• Target exchange rate

• Exchange rate pass-through



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Exhibit 3-4: Foreign Exchange Rates



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4. Balance of Payments

The balance of payment (BOP) of a nation

summarizes all the transactions that take place

between its residents and the residents of other

countries over a specified time period, usually a

month, quarter, or year.

• The BOP transactions contain three categories (see

Exhibit 3-5):

– Current account

– Capital account

– Official reserves

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Exhibit 3-5: U.S. Balance of Payments, 1990 –

2014



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