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Notes on 10 and 15.docx

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University of Ottawa

Chapter 10The Global Monetary SystemTurkeys 18th IMF Program p 32224Meaning of theinternational monetary systempromotes price stability lowering national debt regulates poor countries only Institutional arrangements countries adopt to govern exchange ratesFloating exchange rate when the foreign exchange market determines the relative value of currency US dollar Japanese Yen British Pounds EU Euro the worlds four major trading currenciesfree to float against each otherFlexible exchange rate A system under which the exchange rate for converting one currency into another is continuously adjusted depending on the laws of supply and demand SD influenced by respective countries inflation rates and interest rates These exchange rates are determined by market forces fluctuate against each other on a day to day basis Pegged exchange rate Currency value is fixed relative to a reference currency The exchange rate between the pegged currency and another currency is determined by the reference currencys exchange rate Usually pegged to US or Euro Ex Belize pegs its dollar to the US Dollar The exchange rate between Belizean currency and the Euro would be the US dollarEuro exchange rate Dirtyfloat system Countries that try to hold the value of their dollar within a range against an important reference currency ex US dollar It is a float because value of currency is determined by market but it is dirty because the central bankgovernor of a country will intervene in the foreign exchange market to try to maintain currency value if it depreciates too rapidly Central bank countrys primary monetary authority Bank of Canada Fixed exchange rate A system which the exchange rate for converting one currency into another is fixed at a mutually agreed upon rate EX during WW2 some European states had the same fixed currency through the European Monetary SystemA currency may come under pressure when a nation experience severe economic problems high inflation government debt crisis in the banking systemA government can try to main its currency by using foreign currency ex Canada uses Euros to purchase Canadian dollars held in reserves to buy its own currency in the market thereby increasing demand for the currency and raising its price If they do not have enough currency in reserves they can call on the International Monetary Fund for loans with conditions to help them purchase more currency The Gold Standard p 327328 country prices currencies relative to gold and guaranteeing convertibility pegging Ex 375 Euros per ounce of gold in 1934 it was 35 US dollars for an ounce Canadian dollar was under gold standard from 18541914 The start of WW1 marked the end of the gold standard era People were rushing to convert their paper money into gold but there was not enough gold for everyone Canadas relationship with the gold standard ended in 1933 when an official order was made to suspend the redemption of dominion notes for gold The reason why it wasnt successful was partially because as the price of gold rose more dollars were needed to buy an ounce of gold and therefore dollars were worth less devalued Ex Canada raised the price of gold from 2067 to 30 dollars per ounce Strengths of the Gold StandardPowerful mechanism for achieving balance of trade equilibrium by all countries Balance of trade equilibrium the income residents earn from exports is equal to the money residents pay in other countries for imports surplusexports more Use of gold coins as a medium of exchange when international trade was limited in volume payment for goods from one country to another was made in gold and silver As international trade increased the solution was that paper currency was paid for goods and then paper currency could be turned into gold on demand at a fixed exchange rateGold standard example Imagine the world had 2 countries Japan and US Japan is in a surplus exporting more to US then importing Japan is paid in US dollars by US for exports Japan then converts US dollars to yen in the Japanese Central Bank and then the bank submits the US dollars to the US government and demands gold in return Therefore when Japan has a surplus of trade they have a net inflow of gold from the US these gold flows increase the Japanese money supply and reduce the US money supplyAn increase in Japanese money supply raises prices and decrease demand for goods therefore Japan will start to buy more from USA decrease in US money supply will decrease prices and increase the demand for goods therefore US will buy less from JapanThis will occur until the balance of trade equilibrium is satisfiedThe Bretton Woods System p 329 At height of WW2 44 countries met in the US to design a new international monetary system Since gold standard and depression was over with they wanted to create an economic order that would facilitate postwar
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