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Questions and Answers
Why is there a need for an international payment system?
To facilitate cross-border transactions and trade.
How do countries use the international payment system to achieve internal and external balances?
By managing their currency exchange rates and trade policies.
What are the two extreme exchange rate regimes discussed in the text?
In a currency board arrangement, countries issue their independent currency.
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Countries do not issue an independent currency in exchange arrangements with ______.
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What system was suggested by Halm (1965) under the name of wider band?
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What does a crawling peg arrangement entail?
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Stabilized arrangements entail an exchange rate that remains within a margin of 2% for six months or more.
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Any arrangement that does not fall into hard pegs, soft pegs, or floating regimes is assigned to ______ category.
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Match the following currencies with their characteristics:
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What marked the beginning of the end of the gold exchange standard of the Bretton Woods agreement?
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When did President Nixon declare the dollar to be unconvertible and announced the closure of the Bretton Woods era?
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After the collapse of the Bretton Woods system, another system replaced it.
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The collapse of the Bretton Woods system led to the emergence of a situation named '________.'
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Match the following organizations with their purposes:
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What are the non-concessional loans provided mainly through the IMF?
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Non-concessional facilities are subject to the IMF's market-related interest rate called 'rate of charge'.
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What is the maximum amount that a country can typically borrow from the IMF?
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The ______ provides development assistance to creditworthy poor countries as well as to middle-income countries, similar to IMF's mission to promote growth of poorer countries.
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Study Notes
International Payments System
- The International Payments System is a system used by countries to achieve both internal and external balances.
- The system has evolved over time, with different exchange rate regimes being used.
The Two Extremes and Intermediate Regimes
- The two extremes are:
- Perfectly and freely flexible exchange rates (where the monetary authorities do not intervene in the foreign exchange market)
- Rigidly fixed exchange rates (where the exchange rate is fixed and unchangeable)
- Intermediate regimes include:
- Gold standard (where each national currency has a precisely fixed gold content)
- Gold exchange standard (where a country stands ready to buy or sell a particular foreign currency which is fully convertible into gold)
- Exchange standard (where a country buys and sells foreign exchange at fixed rates)
Classification of Exchange Rate Regimes
- The IMF provides annual reports that classify countries into different exchange rate regimes based on the de facto policies.
- The classification system includes four major categories:
- Hard pegs (where the currency is pegged to another currency or a basket of currencies)
- Soft pegs (where the currency is pegged to another currency or a basket of currencies, but with a degree of flexibility)
- Floating regimes (where the exchange rate is largely market determined)
- Other managed arrangements (where the arrangement does not fit into any of the other categories)
Hard Pegs
- Exchange arrangements with no separate legal tender:
- Formal dollarization (where the currency of another country circulates as the sole legal tender)
- Shared legal tender (where members of a monetary or currency union share the same legal tender)
- Currency board arrangement:
- A monetary arrangement based on an explicit legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate
- The domestic currency is usually fully backed by foreign assets, eliminating traditional central bank functions
Soft Pegs
- Conventional pegged arrangements:
- The country formally or de facto pegs its currency at a fixed rate to another currency or a basket of currencies
- The anchor currency or basket weights are public or notified to the IMF
- Pegged exchange rates within horizontal bands:
- The value of the currency is maintained within certain margins of fluctuation around a fixed central rate
- An example is the European Monetary System (EMS)
- Crawling pegs:
- The currency is pegged at a fixed rate but it is adjusted in small amounts at a fixed rate or in response to changes in selected quantitative indicators
- The commitment to maintaining crawling pegs imposes constraints on monetary policy
- Stabilized arrangements:
- The spot market exchange rate remains within a margin of 2% for six months or more (with the exception of a specified number of outliers or step adjustments)
- The required margin of stability can be met either with respect to a single currency or a basket of currencies
- Crawl-like arrangements:
- The exchange rate must remain within a narrow margin of 2% relative to a statistically identified trend for six months or more (with the exception of a specified number of outliers)
Floating Regimes
- There are two types:
- Pure floating:
- A floating exchange rate is largely market determined, without an ascertainable or predictable path for the rate
- There is no government intervention whatsoever
- Free floating:
- A floating exchange rate can be classified as free floating if intervention occurs only exceptionally and aims to address disorderly market conditions
- The authorities have provided information or data confirming that intervention has been limited to at most three instances in the previous six months, each lasting no more than three business days
- Pure floating:
The Bretton Woods System/Arrangement
- The Bretton Woods system (1944-1973) was a gold exchange standard with important modifications
- Each country declared a par value or parity of its own currency in terms of gold, from which the bilateral parities automatically derived
- However, the only currency convertible into gold at the fixed price of US$35 per ounce of gold was the US dollar, which became the key currency
- The member countries were required to stand ready to maintain the declared parity in the foreign exchange market by buying and selling foreign exchange (usually dollars, which thus became the main intervention currency)
- The modifications consisted in the fact that parity, notwithstanding the obligation to defend it, was unchallengeable, but could be changed in the case of “fundamental disequilibrium” in accordance with certain rules### The Bretton Woods System/Arrangement
- The price of a foreign currency (exchange rate) tends to increase or decrease if there is an excess demand or supply, respectively.
- The monetary authority's intervention is necessary to prevent the exchange rate from moving towards a new equilibrium.
- To maintain a fixed exchange rate, the monetary authority must absorb or supply foreign currency to the market.
The Collapse of the Bretton Woods System
- The system worked well in the 1950s and 1960s, but countries like the US, UK, and France experienced balance of payment deficits due to their failure to adhere to IMF rules.
- The system did not allow for devaluation of currencies, which led to the collapse of the system.
- The IMF designed a policy called Special Drawing Right (SDR) to salvage countries from economic difficulties.
- The US abolished the exchange rate and the system collapsed.
The Current Non-System
- After the collapse of the Bretton Woods system, no other system replaced it, and countries were free to choose their own exchange rate regimes.
- The IMF coined the term "non-system" to describe this situation.
- Each country can choose its own exchange rate regime and notify the IMF.
- Some countries peg their exchange rate to a reference currency, while others form currency areas or monetary unions.
International Financial Institutions
- The International Monetary Fund (IMF) and the World Bank are two major international organizations that deal with economic issues.
- The IMF and the World Bank were created at the Bretton Woods conference in 1944.
- Although the Bretton Woods system collapsed, the institutions created at the conference still exist.
International Monetary Fund (IMF)
- The IMF was set up to deal with monetary issues and has 190 member countries.
- The IMF operates on a quota system, where each member country contributes a certain amount of money based on its economic strength.
- The IMF uses a quota formula to determine a member's relative position.
- The IMF's main functions are surveillance, financial assistance, and technical assistance.
Surveillance
- The IMF examines all aspects of a member's economy that are relevant to its exchange rate and evaluates its performance.
- The IMF provides regular assessments of global prospects, financial markets, and public finance developments.
Financial Assistance
- The IMF provides financial assistance to members in need, with a focus on crisis prevention and mitigation.
- The IMF has developed various loan instruments, including Stand-By Arrangements, the Flexible Credit Line, and the Extended Fund Facility.
- The IMF also provides emergency assistance and concessional loans to low-income countries.
Technical Assistance
- The IMF provides technical assistance to members in areas such as macroeconomic policy, tax policy, and financial sector stability.
- The IMF provides advice and training to officials in member countries.### World Bank vs IMF
• The World Bank raises almost all its funds in financial markets, unlike the IMF, which relies on members' quotas.
World Bank Structure
• The World Bank has evolved into a group of five institutions. • IBRD (International Bank for Reconstruction and Development) lends to governments of middle-income and creditworthy low-income countries. • IDA (International Development Association) provides interest-free loans, credits, and grants to governments of the poorest countries. • IFC (International Finance Corporation) offers loans, equity, and advisory services to stimulate private sector investment in developing countries. • MIGA (Multilateral Investment Guarantee Agency) provides political risk insurance or guarantees to foreign investors against losses caused by non-commercial risks to facilitate foreign direct investment in developing countries.
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Description
This quiz assesses your understanding of the international payment system, its importance, and how countries use it to achieve their economic goals. It covers the objectives and purposes of international payment systems.
