Exchange Rate Regimes: A Historical Perspective The Gold Standard Gold Specie Standard; Gold Bullion Standard Gold Exchange Standard Mint Parity: The.

Presentation on theme: "Exchange Rate Regimes: A Historical Perspective The Gold Standard Gold Specie Standard; Gold Bullion Standard Gold Exchange Standard Mint Parity: The."— Presentation transcript:

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2 Exchange Rate Regimes: A Historical Perspective The Gold Standard Gold Specie Standard; Gold Bullion Standard Gold Exchange 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.

3 Exchange Rate Regimes: History The Bretton Woods System The exchange rate regime that was put in place after WWII can be characterized as Gold Exchange Standard The US government undertook to convert the US dollar freely into gold at a fixed parity of $35 per ounce Other member countries of the IMF agreed to fix the parities of their currencies with the dollar with variation within 1% on either side of the central parity being permissible It was an Adjustable Peg system. Central parity could be changed in the face of “fundamental disequilibrium”.

4 Exchange Rate Regimes: History –In return for undertaking this obligation, the member countries were entitled to borrow from the IMF to carry out their intervention in the currency markets. Beyond a country’s reserve position borrowings are conditional on the country adopting certain policy changes recommended by IMF. –Whenever the exchange rate tended to move out of the  1% band, the central bank had to sell or buy the foreign currency to bring it back within the band. Devaluation/Upvaluation when disequilibrium persisted – Fundamental Disequilibrium

5 Exchange Rate Regimes: History 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.

6 Exchange Rate Regimes: History –This system could work as long as other countries had confidence in the stability of the US dollar –The system came under pressure and ultimately broke down when this confidence was shaken starting mid 1960’s. August 15, 1971, US gave up the commitment to convert dollars into gold at fixed rate. – Abandoned in 1973 after some attempts to fix it and revive it. –Major currencies started floating in early 1973.

7 Major Exchange Rate Agreements –1971 Smithsonian Agreement –1972 European Joint Float Agreement –1976 Jamaica Agreement –1979 European Monetary System (EMS) created –1985 Plaza Accord –1987Louvre Accord –1991Treaty of Maastricht SUBSEQUENT EVOLUTION

8 History of the International Monetary System 1971 Exchange rate turmoil dollar falls off the gold standard –most currencies begin to float on world markets 1971Smithsonian Agreement (Group of Ten) –dollar devalued to $38/oz of gold –other currencies revalued against the dollar –4.5% band adopted 1972 European Joint Float Agreement –“The snake” adopted by EEC

9 The Basle Agreement : 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

10 History of the International Monetary System 1976 Jamaica Agreement 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 –European currency unit (ECU) created

11 The Plaza Accord 1985 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.

12 The Plaza Accord 1985 … 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.

13 The Louvre Accord 1987 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.G6FranceWest Germany JapanCanadaUnited StatesUnited KingdomFebruary 221987ParisItaly 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).currency marketsUS DollarPlaza Accord

14 The Louvre Accord … The Louvre Accord aimed to improve the stability of foreign exchange by the mutual agreement of the G7 Minister of Finance.G7 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.

15 History of the international monetary system 1991Treaty of Maastricht –European community members agree to pursue a broad agenda of economic, financial and monetary reforms –A single European currency is proposed as the ultimate goal of monetary union 1999Introduction of the Euro –Emu-zone currencies are pegged to the euro –European bonds convert to the euro 2002The Euro begins public circulation