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International Monetary System

Explore the benefits of stable exchange rates, the law of one price, purchasing power parity, and factors influencing exchange rates. Learn about the gold standard, Bretton Woods agreement, and today's monetary system. Discover strategies to manage currency values and navigate global markets efficiently. This chapter provides insights into forecasting exchange rates and understanding the mechanisms governing the international financial landscape.

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International Monetary System

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  1. International Monetary System

  2. List the benefits of stable and predictable exchange rates Discuss the law-of-one-price principle Describe purchasing power parity and the factors that affect exchange rates Explain how the gold standard functioned Discuss the experience with Bretton Woods Describe today’s international monetary system Chapter Preview

  3. Exchange rates affect activities of both domestic and international firms export prices raises lowers import prices raises lowers Currency Values and Business Devaluation Revaluation

  4. Major World Currencies

  5. Get lean by shaving production costs Reward customers for paying a higher price Diversify into more currency-proof sectors Follow global demand to maintain sales Freezing prices can generate new sales Strong Currency: Curse or Cure? Export strategies in the face of a strong currency

  6. Improve accuracy of financial planning Reduce surprises of unexpected rate changes Stability and Predictability Stable exchange rates Predictable exchange rates

  7. Value of US Dollar

  8. Undervalued or overvalued Big MacCurrencies Fairly good rate predictor Limited use in business decisions Law of One Price Identical item must have an identical price in all countries when expressed in a common currency

  9. Big Mac Index

  10. Purchasing Power Parity Relative ability of two nations’ currencies to buy the same “basket” of goods in those two nations Considers price levels in adjusting relative currency values Purchasing power of a currency is eroded by inflation

  11. Inflation: Key Factors • Monetary policy directly affects interest • rates and money supply • Fiscal policy indirectly affects taxes • and spending • High employment raises wages, which • are embodied in consumer prices • High rates lower borrowing and spending, • which lowers inflation • Exchange rates adjust to maintain PPP Money supply Employment Interest rates Adjustment

  12. Interest Rates Fisher Effect Nominal Interest rate = real interest rate + inflation rate International Fisher Effect Difference in nominal interest rates supported by two nations’ currencies will cause an equal but opposite change in their spot exchange rates

  13. Evaluating PPP Added costs Trade barriers Business confidence, psychology

  14. Efficient (inefficient) market views Prices reflect (don’t reflect) all public information Forecasting techniques Fundamental analysis Technical analysis Forecasting Exchange Rates

  15. In place from 1700s to 1939 Reduced exchange-rate risk Restricted monetary policies Corrected trade imbalances Ended by “competitive devaluation” Gold Standard International monetary system that linked nations’ currencies to specific values of gold

  16. Fixed exchange rates Built-in flexibility World Bank and IMF Ended by weak US dollar Bretton Woods Agreement International monetary system based on value of US dollar (1944 to 1973)

  17. Jamaica Agreement Formalized the system of floating exchange rates as the new international monetary system (1976) Managed float system Currencies float with government intervention Free float system Currencies float without government intervention

  18. Managed float system Pegged exchange rates Currency board European monetary system The System Today

  19. Developing nations’ debt crisis • Mexico • Southeast Asia • Russia • Argentina Recent Financial Crises

  20. This chapter presents factors that help determine exchange rates and how exchange rates can be forecasted. It discusses the mechanisms designed to manage exchange rates, including the international monetary system and the European monetary system. The law of one price stipulates that an identical product must have an identical price in all countries when price is expressed in the same currency. Purchasing power parity is the relative ability of two countries’ currencies to buy the same “basket” of goods in those two countries. The efficient market view of forecasting exchange rates states that prices of financial instruments reflect all publicly available information at any given time. The inefficient market view holds that prices of financial instruments do not reflect all publicly available information. The gold standard was a monetary system that pegged currencies to gold and guaranteed convertibility to gold. The Bretton Woods system of fixed exchange rates was established in 1944. Today, the international monetary system remains in large part a managed-float system whereby most nations’ currencies float against one another with government intervention to realign exchange rates when necessary. Chapter Summary

  21. International Monetary System

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