The International Monetary System and the Balance of Payments

1. The International Monetary System and the Balance of Payments LECTURE : Mahsina, SE.,Msi Group 2: M. ZainulArifin (11.021.084) YessiWulan S. (11.021.115)

2. The Development of the International Monetary System • The Gold standard • The Bretton Woods Era

3. The Gold Standard • Countries agree to buy or sell their paper currencies in exchange for gold on the request of any individual or firm and to allow the free export of gold bullion and coins • Created a fixed exchange rate

4. Exchange Rates • Exchange rate: price of a one currency in terms of a second currency • Fixed exchange rate system: price of a given currency does not change relative to each other currency • Under the gold standard, each country pegged the value of its currency to gold

5. The Collapse of the Gold Standard • Economic pressures of WWI • Countries suspended pledges to buy or sell gold at currencies’ par values • Gold standard readopted in 1920s • Dropped during Great Depression • British pound allowed to float in 1931 • Float: value determined by supply and demand

6. The Bretton Woods Era • 44 countries met in Bretton Woods, New Hampshire in 1944 • Goal: to create a postwar economic environment to promote worldwide peace and prosperity • Renewed gold standard on modified basis (dollar-based) • Created International Bank for Reconstruction and Development and International Monetary Fund

7. The End of the Bretton Woods System • Susceptible to speculative “runs on the bank” • U.S. $ became only source of liquidity necessary to expand international trade • Triffin Paradox: • foreigners increased holdings of dollars • Increased holdings decreased faith in U.S ability • Increased demand for redeeming dollars for gold • IMF created special drawing rights (SDRs) – paper gold • Bretton Woods system ended August 15, 1971

8. International Monetary System since 1971 • Development of floating exchange rate system • Supply and demand for a currency determine its price in the world market • Managed float – central banks can affect supply and demand • Legitimized in 1976 with the Jamaica Agreement

9. European Union • Believed flexible system would hinder ability to create integrated economy • Created European Monetary System to manage currency relationships • ERM participants maintained fixed exchange rates among their currencies • Facilitated creation and adoption of Euro

10. Balance of Payments (BOP) Accounting System • Double entry bookkeeping system • Measures and records all economic transactions between residents of one country and residents of all other countries during specified time period • Provides understanding of performance of each country’s economy in international markets • Signals fundamental changes in country competitiveness • Assists policy makers in designing appropriate public policies

11. Aspects of the BOP Accounting System • Records international transactions made in some time period • Records only economic transactions • Records transactions between residents of one country and all other countries • Residents include individuals, businesses, government agencies, nonprofit organizations • Uses a double-entry system

12. Major Components of the BOP Accounting System • Current Account • Capital Account • Official Reserves • Errors and Omissions

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