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Chapter 7 – The International Monetary System and the Balance of Payments
The International Monetary System
-Exists because most countries have their own currencies.
- Establishes the rules by which countries value and exchange their currencies.
Balance of Payments (BOP) Accounting System
-Records international transactions and supplies vital information about the health of a national
economy and likely changes in its fiscal and monetary policies.
-Can be used to detect signs of trouble that could eventually lead to government trade restrictions,
higher interest rates, accelerated inflation, and general changes in the cost of doing business in any
History of the International Monetary System
The Gold Standard
-Under the Gold standard countries agree to buy or sell their paper currencies in exchange for gold.
-This effectively created a fixed exchange rate system.
Exchange rate is the price of one currency in terms of a second currency.
Fixed exchange rate system: when the price of a given currency does not change relative to each other
-From 1821 until the end of WWI in 1918, the most important currency in international commerce was
the British pound sterling. Therefore the international monetary system during this time is called the
Sterling-based Gold Standard.
-The economic pressures of war caused countries to suspend their pledges to buy or sell gold at their
currencies’ par values.
The Bretton Woods Era
-Conference that resulted in the creation of two new international organizations that would assist in
rebuilding the world economy and the international monetary system.
1) The International Bank for Reconstruction and Development
2) The International Monetary Fund
The International Bank for Reconstruction and Development (IBRD) – is the official name of the
-initial goal was to help finance reconstruction of the war-torn European economies. After it
accomplished this task, it adopted a new mission: to build the economies of the world’s developing
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-The World Bank may lend only for “productive purposes” that will stimulate economic growth within
the recipient country.
-The World Bank must follow a ‘hard loan policy’. It may make a loan only if there is reasonable
expectation that the loan will be repaid.
The World Bank has created 3 affiliated Organizations:
1) The International Development Association (IDA)
- Offers ‘soft loans’, loans that bear some significant risk of not being repaid.
-Carries no interest rate.
2) The International Finance Corporation (IFC)
- Promotes the development of private sectors in developing countries.
3) The Multilateral Investment Guarantee Agency (MIGA)
- Encourages direct investment in developing countries by offering private investors insurance against
Regional Development Banks- promote the economic development of the poorer countries in their
The International Monetary Fund (IMF)
-Oversees the functioning of the international monetary system.
1. To promote international monetary cooperation
2. To facilitate the expansion and balanced growth of international trade.
3. To promote exchange stability.
4. To assist in the establishment of a multilateral system of payments.
5. To give confidence to members by making the general resources of the IMF temporarily
available to them and to correct maladjustments in their balance of payments.
6. To shorten the duration and lessen the degree of disequilibrium in the international balance of
payments of members.
-To join the IMF a country must pay a quota (deposit), partly in gold and partly in the countries currency.
-A country’s quota determines its voting power within the IMF.
Convertible currencies - Ones that can be freely exchanged for other currencies without legal
- When the central bank representatives agreed to restore the fixed exchange rate system but
with restructured rates of exchange between the major trading currencies.
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