Chapter 3 Notes – Final Exam
The International Monetary System
The gold standard: each country set the rate at which its currency united could be converted to a weight
of gold. Each government of each country on the gold standard agreed to buy or sell gold on demand
with anyone at its own fixed parity rate, the value of each individual currency at terms of gold, and
therefore exchange rates between currencies, was fixed.
- WW1 caused main trading nations to suspend operation of the gold standard.
Selling short: a speculation technique in which an individual speculator sells an asset such as a currency
to another party for delivering at a later dater. The speculator, however, does not yet own the asset,
and expects the price of the asset to fall by the date when the asset must be purchased in the open
market by the speculator for delivery.
-modified gold standard was adopted in 1934 --- U.S. Treasury traded gold only with foreign central
banks, not private citizens. From 1934 to the end of WW2, exchange rates were theoretically
determined by each currency’s value in terms of gold.
-After WW2, allied power created two new systems: the International Monetary Fund and the World
- IMF aids countries with balance of payments and exchange rate problems.
- World Bank helps fund postwar reconstruction and has supported general economic
IMF: established to render temporary assistance to member countries trying to defend their currencies
against cyclical, seasonal, or random occurrences. Also assists countries having structural trade
problems if they promise to take adequate steps to correct their problems. Loans + advice.
- Under the original provisions of the Bretton Woods Agreement, all countries fixed the values of
their currencies in terms of gold but were not required to exchange their currencies for gold.
- Gold-Exchange Standard: - dollar contervible to gold ---- each country established its exchange
rate vis-a-vis the dollar, then calculated the gold par value of its currency to create the desired
dollar exchange rate. Participating countries agreed to try to main the value of their currencies
within 1% of par by buying or selling foreign exchange or gold as needed.
- Special Drawing Right: an international reserve asset created by the IMF to supplement existing
foreign exchange reserves . Serves as a unit of account for the IMF and other international and
regional organizations, and is also the base against which some countries the echange rate for
their currencies. Currently the weighted average of four major currencies: US dollar, euro, yen,
and British pound.
- August 15, 1971 – Nixon suspended official purchases or sales of gold by the US treasury.
IMF Exchange Rate Regime Classifications
1. Exchange arrangements with no separate legal tender: the currency of another country
circulates as the sole legal tender or the member belongs to a monetary or currency union in
which the same legal tender is shared by the members of the union.
2. Currency board arrangements: a monetary regime based on an implicit legislative commitment
to exchange domestic currency for a specified foreign currency at a fixed exchange rate, combined with restrictions on the issuing authority to ensure the fulfillment of its legal
3. Other conventional fix peg arrangements:? The country pegs its currency at a fixed rate to a
major currency or a basket of currency, where the exchange rate fluctuates within a narrow
margin or at most plus or minus 1 % around a central rate.
4. Pegged exchange rates within horizontal bands: the value of the currency is maintained within
margins of fluctuation around a formal or de facto dixed peg that are wide than /./..//.///
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- Most prominent example of a rigidly fixed system: euro single currency for its member
countries. However, the euro itself is an independently floating currency against all other
o EGs panama, Ecuador – use US dollar
o Central African Franc Zone
o Easter Caribbean Currency Union