CHAPTER - 5. The International Monetary System. International Financial Management P G Apte. Exchange Rate Regimes: A Historical Perspective. The Gold Standard Gold Specie Standard; Gold Bullion Standard Gold Exchange Standard
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International Financial Management
P G Apte
Gold Specie Standard; Gold Bullion Standard
• Mint Parity: The exchange rate between any pair of currencies will be determined by their respective exchange rates against gold
• The gold standard regime imposes very rigid discipline on the policy makers :
• The money supply in the country must be tied to the amount of gold the monetary authorities have in reserve.
When a country loses (gains) gold, money supply must contract (expand).
• Domestic economy governed by external sector.
The exchange rate regime that was put in place after WWII can be characterized asGold Exchange Standard
It was anAdjustable Pegsystem. Central paritycould be changed in the faceof “fundamental disequilibrium”.
Intervention operations affect the domestic money supply and then the price level, GNP etc.
These effects may have an automatic corrective effect – Central bank sells forex, money supply contracts, price level reduces, GNP reduces, imports decline, the pressure on home currency reduces.
Central bank can “sterilize” these effects.
dollar falls off the gold standard
1971 Smithsonian negotiations led to official renunciation of gold/dollar convertibility and unilateral devaluation of the US dollar by nine per cent.
Modified version of fixed exchange rates with managed, adjustable parities.
Notion of irrevocably locking exchange rates together without any margin of fluctuation was abandoned in favour of mechanism to reduce margin of fluctuation around the central parities . Intra-EEC exchanges confined to a narrower band of fluctuation than was permitted in respect of EEC currencies against the dollar (the ‘snake in the tunnel’).
The Basle Agreement, March 1972 reduced intra-EEC exchange rate fluctuations to 2.25 per cent the “snake in the tunnel” . “Tunnel” set at 4.5 % “snake” confined to a margin of 2.25%.
European currencies used as means of central bank intervention while dollar deployed to prevent the snake from leaving the tunnel.
The six original members of the currency bloc joined by Ireland, the UK, Denmark and Norway
Floating rates declared “acceptable”
1979 European Monetary System (EMS)
European Exchange Rate Mechanism
(ERM) established to maintain currencies
within a 2.25%band around central rates
1987 Louvre Accord
The Group of Five agree to maintain current levels – not to allow the US dollar to slide down any further
In 1985 inflation was low and growth was rapid. The US was experiencing a large and growing trade deficit, caused in part by the rising dollar. Japan and Germany were facing large and growing surpluses. This imbalance threatened to upset the foreign exchange market.
The 80% appreciation in value of the US dollar against the currencies of its major trading partners was seen as the source of the problems.
A US dollar with a lower valuation would help stabilize the global economy- creating a balance between the exporting and importing capabilities of all countries.
Devaluing the dollar made US exports cheaper for its trading partners, which caused other countries to buy more American-made goods and services.
The US persuaded the leaders to coordinate a multilateral intervention, designed to allow for a controlled decline of the dollar and the appreciation of the main anti-dollar currencies.
Each country agreed to make changes in it\'s economic policies and to intervene in currency markets as necessary to bring down the value of the dollar.
Agreement between the then G6 (France, West Germany, Japan, Canada, the United States and the United Kingdom) on February 22, 1987 in Paris, France. Italy had been an invited member, but declined to finalize the agreement.
The goal of the Louvre Accord was to stabilize the international currency markets and halt the continued decline of the US Dollar caused by the Plaza Accord (of which a primary aim was depreciation of the US dollar in relation to the Japanese yen and German Deutsche Mark).
The Louvre Accord aimed to improve the stability of foreign exchange by the mutual agreement of the G7 Minister of Finance.
Since the Plaza accord, the dollar rate had continued to slide, reaching an exchange rate of ¥150 per US$1 in 1987. The ministers of the G7 nations gathered at the Louvre in Paris to "put the brakes" on this decline. It was assumed that a lower dollar valuation might stall economic growth world-wide. The monetary authorities of the G7 ministers agreed to cooperate to stabilize exchange rates.
Mexican stock market value (in local currency)
(Dec 31, 1993 = 1.00)
The Relevant Aspects of the System
Is there an “ideal” regime?
Full Capital Controls
Monetary PolicyStable Exchange
Floating RateIntegrationCurrency Union
International Reserves = Reserve position in IMF + SDRs + Forex assets held by central bank
Currency Currency Amount Exchange Rate U.S.
Euro 0.4100 1.41320 0.579412
Japanese Yen 18.4000 95.67000 0.192328
Pound Sterling 0.0903 1.65660 0.149591
U.S. dollar 0.6320 1.00000 0.632000
US$ 1.00 = SDR 0.643778
SDR 1 = US$ 1.55333
(Note: EUR,GBP rates stated as $ per EUR and $ per GBP. JPY rate stated
as JPY per $ )
Adjustment more urgent for deficit countries.