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Unit 2: International Monetary System

gold sale and dollar buying. Initially, the magnitude of the action took the market by Notes
surprise. Gold prices dropped and the bond market, stock market and dollar all rose
significantly. Yet, by the end of the month, the strong anti-inflation policies themselves
weakened the confidence in the government and chaos ensued. Additional panic selling
drove the dollar to record lows. Once again, by allowing the dollar to float, the traditional
adverse consequences of market closings and official devaluation were averted.
Under a flexible or floating system, the market force, based on demand and supply,
determines a currency’s value. A surplus in a country results in an appreciation of its
currency, immediate higher prices, mass reserve and opportunity costs. In addition, too
much money on reserve leads to a loss of investment opportunities. On the other hand, a
country’s deficit will lower its currency value, making it easier to export more later.

Self Assessment

Fill in the blanks:
1. Under a …………………… system, the market force, based on demand and supply,
determines a currency’s value.

2. Too much money on reserve leads to a loss of …………………… opportunities.
3. Under the …………………… scheme, a country pursuing more inflationary policies will
find the prices of its international goods going up.

4. The disadvantage of …………………… system is that it requires countries to have ample
reserves for the prolonged process of adjustment.
5. The basic role of the …………………… would be to help countries with balance of payments
and exchange rate problems.
6. The World Bank would help countries with post-war reconstruction and general
…………………… development.

7. The negotiators at Bretton Woods made certain recommendations in …………………….
8. The fundamental principle of the classical gold standard was that each country should set
a …………………… value for its currency in terms of gold and then try to maintain this
value.

2.2 Classification of Currency Arrangements – Present Day Currency

Regimes

A recent classification of the world’s currencies, as published in the IMF publication, International
Financial Statistics, is shown in Table 2.1:

More flexible exchange rate systems: Countries such as the Japan and United States are in a
more flexible exchange rate system in which currency values are allowed to float in
relation to each other. Government intervention has a significant impact on currency
values, especially in the short-term. Thus these currencies are not in a truly floating rate
system.
Though managed floating exchange rate systems have no official bounds on currency
values, governments do intervene in this system in order to accomplish their policy
objectives. Managed floating systems allows governments to implement their policy
objectives within a relatively flexible exchange rate system and to coordinate monetary
policies with other governments if they choose.

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