International Monetary SystemOrganization of LectureAlternative Exchange Rate SystemsUnder a floating rate system, exchange rates are set by demand and supply.Important Note:Alternate exchange rate systems: Managed Float (“Dirty Float”)Alternate exchange rate systems: Fixed Rate SystemAn alternative is to simply instruct the monetary authority to buy stand willing to buy or sell currency at the desired rate.Final noteA Brief History of the International Monetary SystemThe Intrinsic Value of MoneyAt various times some countries have minted coins in both gold and silver (referred to as bimetallism) The U.S., for example, has circulated gold and silver coins at the same time.The Classical Gold Standard (1875-1914)Advantage of Gold SystemInterwar PeriodSlide 16The Bretton Woods System (1946-1971)Real GDP in German During B-W PeriodCollapse of Bretton Woods (1971)Current Exchange Rate Arrangements (IMF ClassificationSlide 21The Mexican Peso CrisisSlide 23The Asian Currency Crisis (1997)The Asian Currency CrisisThe Argentinean Peso CrisisSlide 27Slide 28Currency Crisis ExplanationsThe European ExperienceBenefits of a single currencyCosts of a Single CurrencyInternational Monetary SystemInternational Monetary SystemOrganization of LectureOrganization of LectureALTERNATIVE EXCHANGE RATE SYSTEMSALTERNATIVE EXCHANGE RATE SYSTEMSA BRIEF HISTORY OF THE INTERNATIONAL A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEMMONETARY SYSTEMTHE EUROPEAN MONETARY SYSTEMTHE EUROPEAN MONETARY SYSTEMCosts and benefits of a single currencyCosts and benefits of a single currencyAlternative Exchange Rate SystemsAlternative Exchange Rate SystemsOverviewOverview : If people who don’t ordinarily use the same : If people who don’t ordinarily use the same currency are going to trade, there must be some way of currency are going to trade, there must be some way of exchanging currency. (If you want a Porsche, you’ve got to exchanging currency. (If you want a Porsche, you’ve got to get German marks, or now the euro). There are an get German marks, or now the euro). There are an enormous number of exchange rate systems, but generally enormous number of exchange rate systems, but generally they can be sorted into one of these categoriesthey can be sorted into one of these categories–Freely Floating Freely Floating –Managed FloatManaged Float–Target ZoneTarget Zone–Fixed RateFixed Rate–Hybrid HybridUnder a Under a floating rate systemfloating rate system, exchange , exchange rates are set by demand and supply.rates are set by demand and supply.The model of demand and supply is extremely The model of demand and supply is extremely useful in explaining exchange rates under a useful in explaining exchange rates under a floating system (just make sure you keep track floating system (just make sure you keep track of what currency is purchased and what is of what currency is purchased and what is sold). sold). Any number of factors might influence exchange Any number of factors might influence exchange rates, includingrates, including–price levels price levels –interest ratesinterest rates–economic growtheconomic growthImportant Note:Important Note:Even though we may call it “free float” in fact the Even though we may call it “free float” in fact the government can still control the exchange rate by government can still control the exchange rate by manipulating the factors that affect the exchange rate manipulating the factors that affect the exchange rate (i.e., monetary policy)(i.e., monetary policy)Alternate exchange rate systems: Alternate exchange rate systems: Managed Managed Float (“Dirty Float”)Float (“Dirty Float”) Market forces set rates unless excess volatility occurs, then, Market forces set rates unless excess volatility occurs, then, central bank determines rate by buying or selling currency. central bank determines rate by buying or selling currency. Managed float isn’t really a single system, but describes a Managed float isn’t really a single system, but describes a continuum of systemscontinuum of systems–Smoothing daily fluctuationsSmoothing daily fluctuations–““Leaning against the wind” slowing the change to a different Leaning against the wind” slowing the change to a different raterate–Unofficial pegging: actually fixing the rate without Unofficial pegging: actually fixing the rate without saying so.saying so.–Target-Zone ArrangementTarget-Zone Arrangement: countries agree to maintain : countries agree to maintain exchange rates within a certain bound What makes target exchange rates within a certain bound What makes target zone arrangements special is the understanding that zone arrangements special is the understanding that countries will adjust real economic policies to maintain the countries will adjust real economic policies to maintain the zone.zone.Alternate exchange rate systems: Alternate exchange rate systems: Fixed Rate Fixed Rate SystemSystemOne way to do this is to dictate an exchange rate and One way to do this is to dictate an exchange rate and shoot people who try to trade currency at anything shoot people who try to trade currency at anything other than the official exchange rate. Price controls other than the official exchange rate. Price controls are hard to enforce (and even if they could be are hard to enforce (and even if they could be enforced lead to a misallocation of resources).enforced lead to a misallocation of resources).An alternative is to simply instruct the An alternative is to simply instruct the monetary authority to buy stand willing to buy monetary authority to buy stand willing to buy or sell currency at the desired rate.or sell currency at the desired rate.A fixed rate system is the ultimate good news bad news joke. A fixed rate system is the ultimate good news bad news joke. The good is very good and the bad is very bad.The good is very good and the bad is very bad.–Advantage: stability and predictabilityAdvantage: stability and predictability–Disadvantage: the country loses control of monetary policy Disadvantage: the country loses control of monetary policy (note that monetary policy can always be used to control an (note that monetary policy can always be used to control an exchange rate).exchange rate).At some point a fixed rate may become unsupportable At some point a fixed rate may become unsupportable and one country may