Since the beginning of the 19th century, globalization, international trade and free trade between countries became the new economic order and several attempts have been made since then to develop policies and schemes to ensure the stability of the international monetary system. It is safe to say that in truth, the world economy has never been in a state of utopia, but nevertheless, we have never stopped trying to attain such. The Bretton Woods era of 1944 to 1977, one of the few fairly successful schemes the world powers created in trying to achieve economic utopia, though existed for a short period, has been accredited as being one of the most successful international monetary systems, so impressive was the economic stability and growth of the era that there have been ongoing talks for a comeback of the system. Background of the Bretton Woods System At the end of the World Continue reading
Exchange Rate System
Detailed Information about Bretton Woods Exchange Rate System and The Special Drawing Rights (SDRs)
Bretton Woods Exchange Rate System (1944) In 1944, as World War II drew toward a close, the Allied Powers met at Bretton Woods, New Hampshire, in order to create a new post-war international monetary system. The Bretton Woods Agreement, implemented in 1946, whereby each member government pledged to maintain a fixed, or pegged, exchange rate for its currency vis-Ã -vis the dollar or gold. These fixed exchange rates were supposed to reduce the riskiness of international transactions, thus promoting growth in world trade. The Bretton Woods Agreement established a US dollar-based international monetary system and provide for two new institutions, The IMF and the World Bank. The IMF aids countries with balance of payments and exchange rate problems. The International Bank for Reconstruction and Development (World Bank) helped post-war reconstruction and since then has supported general economic development. The IMF was the key institution in the new international monetary system, and Continue reading
Exposures to Exchange Rate Fluctuations
International business is facilitated by markets that allow flow of funds between countries in different currencies. Multinational corporations are involved in international trade and receive and pay in various currencies. MNCs must constantly monitor exchange rates because their cash flows are highly dependent on them. The risk faced by these companies due to exchange rate movements after having already entered into financial obligations is called exchange rate risk. Such exposure to fluctuating exchange rates can lead to major losses for the firms. Exchange rate fluctuations cannot be forecast with accuracy. However, using various techniques, the amount of exposure can be measured and minimized. Exchange rate fluctuations can be broadly categorized into three types: Transaction exposure Economic exposure Translation exposure Transaction exposure arises when a firm’s contractual cash flows are affected by fluctuations in exchange rates of the currencies in which they are designated. Transaction exposures can have a great impact Continue reading
The Current Scenario of Exchange Rate Regimes
Now the IMF classifies member countries into eight categories according to the Exchange rate regime they have adopted. A brief summary of IMF’s classification is given below: 1. No Separate Legal Tender Arrangement This group includesa) Countries which are members of a currency union and share a common currency like the twelve members of the European Currency Union (ECU), who have adopted Euro as their common currency orb) Countries which have adopted the currency of another country as their currency. IMF’s 1999 Annual Report on Exchange Arrangements and Exchange Restrictions indicates that 37 countries belong to this category. 2. Currency Board Arrangement A regime under which there is a legislative commitment to exchange the domestic currency against a specific foreign currency at a fixed exchange rate coupled with restrictions on the monetary authority to ensure that this commitment will be honored. This implies constraints on the ability of the monetary Continue reading
Floating Exchange Rate Systems Era
The Floating Rate Exchange Systems Era: 1973-onwards This period of floating rates experienced a relatively high volatility of the exchange rates. The US dollar surged ahead against all major currencies till 1984 and then the intervention of G-10 countries helped the sliding down of the dollar. The period also witnessed two quick shocks due to the excessive hike of the petroleum prices in 1973 and 1977 and that induced inflation in the world and changed the terms of trade of the petroleum importing countries. The major characteristics of this period can be put in order. The USA experienced a large current deficit, which touched $ 100 billion in 1990 with a very low saving-income ratio at the domestic level. On the other hand Germany and Japan experienced large current account surplus. There has been a global insolvency problem as a large number of countries became unable Continue reading
Is there an Optimal Exchange Rate Regime?
Starting from the gold standard regime of fixed rates, passing through the adjustable peg system after the Second World War, it has finally ended up with a system of managed floats after 1973. Since 1985, the pendulum has started swinging, though very slowly and erratically, in the direction of introducing some amount of fixity and rule based management of exchange rates. Despite these empirical facts, there is a school of thought within the professional which argues that in the years to come there will be only two types of exchange rate regimes: truly fixed rate arrangements like currency unions or currency boards, or truly market determined, independently floating exchange rates. The “middle ground” — regimes such as adjustable pegs, crawling pegs, crawling bands and managed floating — will pass into history. Some analysts even predict that three currency blocks — the US dollar block, the Euro block and the Yen Continue reading