International Monetary Systems: A Historical Outlook

Introduction

• This session explores the evolution of global monetary frameworks.
• From the Gold Standard era to the current system of floating exchange rates.
• Highlights key transitions, including:
  • The interwar instability.
  • The formation and eventual collapse of the Bretton Woods System.
  • The move toward monetary flexibility and financial globalization.

Historic Overview from the 20th Century

• Gold Standard (1870–1914):
  • Fixed exchange rates.
  • Reliance on gold reserves.
  • Stability but prone to deflation.
• Interwar Period (1918–1939):
  • Economic instability.
  • Competitive devaluations.
  • Trade restrictions.
  • Collapse of financial cooperation.
• Bretton Woods System (1944–1973):
  • Fixed exchange rates tied to the U.S. dollar.
  • IMF and World Bank created to manage global monetary stability.
• Floating Exchange Rates (1973–present):
  • Greater exchange rate flexibility.
  • Increased financial market volatility.
  • Policy independence.

The Gold Standard (1870-1914)

• Countries pegged currencies to gold, ensuring stable exchange rates.
• Limited monetary policy autonomy as money supply depended on gold reserves.
• Facilitated international trade but caused deflationary pressures during economic downturns.

The Interwar Period (1918-1939)

• The gold standard was abandoned during WWI, leading to inflation and currency instability.
• The League of Nations (1920) was created to maintain world peace and promote cooperation.
• The Great Depression (1929) worsened economic conditions, with high unemployment and reduced global trade.
• Competitive devaluations and protectionist policies, such as the Smoot-Hawley Tariff, contributed to financial disintegration.

The Bretton Woods System

• Created in 1944 to provide exchange rate stability and prevent competitive devaluations.
• U.S. dollar was pegged to gold at 35 per ounce, while other currencies were fixed to the dollar.
• Countries could adjust exchange rates under IMF supervision in cases of "fundamental disequilibrium."

Goals of the Bretton Woods System

• Full Employment:
  • Prevent economic crises like the Great Depression by ensuring macroeconomic stability.
• Exchange Rate Stability:
  • Fixed but adjustable exchange rates to promote confidence in international transactions.
• Economic Growth:
  • Facilitate post-war reconstruction and development through coordinated international cooperation.

Stucture of the IMF

• Oversees the stability of exchange rates and provides short-term financial assistance to countries facing balance-of-payments crises.
• Members contribute to a financial pool, from which countries can borrow under strict policy conditions.
• Acts as a global monetary policy monitor, guiding nations on financial stability and economic reform measures.

Structure of the World Bank

• Established to fund post-war reconstruction and long-term development projects.
• Provides low-interest loans and grants to developing nations for infrastructure, education, and poverty reduction.
• Helps nations implement structural reforms to modernize economies and improve living standards.

World Bank Assistance: Big Infrastructure

• Pros:
  • Improves productivity and connectivity (e.g. better transport = lower costs).
  • Attracts private investment.
  • Creates jobs (especially in the short term).
  • Enables trade and access to markets.
• Cons:
  • Expensive and slow to implement.
  • Prone to corruption or poor management.
  • Benefits can be uneven (favoring urban or wealthy areas).

World Bank Assistance: Human Capital

• Pros:
  • Directly improves individual productivity and income.
  • Builds long-term, inclusive growth.
  • Better health = better work and school performance.
  • Strong correlation with innovation and adaptability.
• Cons:
  • Results take longer to materialize.
  • Requires sustained investment and good governance.

Challenges to Bretton Woods

• U.S. inflation and trade deficits in the 1960s weakened confidence in the dollar peg to gold.
• Growing international financial flows made fixed exchange rates increasingly difficult to maintain.
• Speculative pressures forced the collapse of the system between 1971 and 1973.

End of Bretton Woods and Rise of Floating Rates

• Nixon Shock (1971):
  • U.S. suspended gold convertibility, leading to instability.
• Official shift to floating rates in 1973:
  • Allowed market forces to determine exchange rates.
  • Increased exchange rate volatility but greater monetary policy independence for countries.

Case Study - First Years of Floating Rates (1973-1990)

• Oil Shocks (1973, 1979):
  • OPEC price hikes caused inflation and exchange rate fluctuations.
• Plaza Accord (1985):
  • Coordinated intervention to depreciate the U.S. dollar against the yen and mark.
• Financial deregulation:
  • Led to increased capital mobility and speculative currency trading.

Key Takeaways from 20th Century Monetary Systems

• Shift from fixed to flexible exchange rates due to market and policy pressures.
• Creation of global financial institutions (IMF, World Bank) to manage stability.
• Continued challenges in balancing national policies with international monetary cooperation.

Period, Exhange Rate Regime, Key Events/Characteristics, Role of Intitutions, Economic Consequences Table

• Gold Standard (1870-1914)
  • Fixed exchange rates tied to gold
  • Stable exchange rates
  • Limited monetary policy (gold reserves dictated money supply)
  • Encouraged international trade
  • Post-WWI abandonment of gold
  • Currency Instability
  • None (no global monetary institutions existed yet)
  • Stability and trade growth
  • Deflation during downturns
  • Limited flexibility for crisis response
• Interwar Period (1918-1939)
  • Attempted return to gold, then chaotic float
  • Great Depression (1929)
  • Competitive devaluations
  • Protectionist trade policies (e.g., Smoot-Hawley Tariff)
  • League of Nations (limited economic role)
  • Some temporary economic stimulus from devaluations
  • Severe unemployment
  • Trade collapse
  • Financial disintegration
• Bretton Woods System (1944-1973)
  • Fixed but adjustable rates tied to USD (which was pegged to gold)
  • Created post-WWII to stabilize global economy
  • IMF and World Bank founded
  • Dollar pegged to gold (35/oz)
  • Adjustable pegs under IMF rules
  • IMF: supervised exchange rates, lent to countries in crisis
  • World Bank: funded post-war reconstruction and development
  • Stability and growth
  • Boosted international cooperation
  • U.S. deficits led to pressure on dollar-gold peg
  • System collapsed in early 1970s
• Floating Exchange Rate Era (1973-present)
  • Floating exchange rates determined by market forces
  • End of gold convertibility (Nixon Shock)
  • Exchange rate volatility
  • Plaza Accord (1985)
  • Financial deregulation and globalization
  • IMF: now focuses on surveillance, policy advice
  • World Bank: continues development work
  • Greater monetary policy autonomy
  • Flexibility to respond to shocks
  • Volatility in exchange rates
  • Speculative capital flows and financial crises

Key Aspects from Session

• Gold Standard (1870–1914):
  • Fixed rates, monetary discipline, but limited flexibility.
• Interwar Period:
  • Currency instability, protectionism, and economic disintegration.
• Bretton Woods (1944–1973):
  • Fixed-but-adjustable exchange rates anchored to the U.S. dollar.
• Post-1973:
  • Shift to floating rates, allowing greater policy autonomy but increased volatility.

Evolution of Exchange Rates Regimes

• IMF:
  • Surveillance of exchange rate stability, financial assistance during balance-of-payments crises, and economic policy guidance.
• World Bank:
  • Long-term development financing, structural reforms, and poverty reduction efforts in developing nations.

Test Questions

• What was a key feature of the Gold Standard (1870–1914)?
  • D. Fixed exchange rates based on gold reserves
• Which event contributed to the collapse of the Bretton Woods system?
  • B. The U.S. suspension of gold convertibility in 1971 (Nixon Shock)
• What was a main goal of the Bretton Woods system?
  • B. Ensure global macroeconomic stability and prevent competitive devaluations
• Which of the following was a challenge during the Interwar Period (1918–1939)?
  • C. Competitive devaluations and rising protectionism