CH 11 - The International Monetary System

(Q) Imposing a fixed exchange rate affects countries in which two ways?

- it prevents competitive devaluations and brings stability to global trade - it imposes monetary discipline on countries

(Q) The unpredictability of exchange rate movements in the post-Bretton Woods era has resulted in which two issues?

- made international business planning difficult - added risk to exporting and importing

balance-of-trade equilibrium ex

Suppose there are only two countries in the world, Japan and the United States. Imagine Japan's trade balance is in surplus because it exports more to the United States than it imports from the United States. Japanese exporters are paid in U.S. dollars, which they exchange for Japanese yen at a Japanese bank. The Japanese bank submits the dollars to the U.S. government and demands payment of gold in return. (This is a simplification of what would occur, but it will make our point.)

(quiz) The Bretton Woods agreement created which of the following two multinational institutions?

The International Monetary Fund and the World Bank

Moral hazard

arises when people behave recklessly because they know they will be saved if things go wrong

(Q) China's trade balance is in surplus because it exports more to Great Britain than it imports from Great Britain. China and Great Britain are NOT in ___ - of - ___ equilibrium

balance of trade

(quiz) A country is said to be in ____ when the income its residents earn from exports is equal to the money its residents pay to other countries for imports.

balance-of-trade equilibrium

(Q) Foreign exchange rates have been more volatile since 1973 due to the many ___ that have occurred in this period

crises

(Q) A(n) ___ is a monetary authority which is required to maintain a fixed exchange rate with a foreign currency

currency board

(Q) When a government intervenes in the currency market to limit volatility of its currency, a(n) ___ system exists

dirty-float

(quiz) Which of the following refers to a system under which a country's currency is nominally allowed to float freely against other currencies but in which the government will intervene, buying and selling currency, if it believes that the currency has deviated too far from its fair value?

dirty-float system

(quiz) The executive managers of Auto International, a U.S.-based multinational car manufacturer, want to reduce the vulnerability of the company to unpredictable exchange rate movements. Which of the following would provide the company with a hedge against currency fluctuations?

dispersing production to different locations around the globe

(Q) The goal of Bretton Woods was to create a long-lasting ___ that would encourage growth after the war

economic order

(Q) When the values of a set of currencies are set against each other at some mutually-agreed on exchange rate, a ___ exchange rate exists

fixed

(quiz) In a ____ exchange rate system, the values of a set of currencies are set against each other at some mutually agreed-on exchange rate

fixed

(Q) A pegged exchange rate means the value of a currency is

fixed relative to a reference currency, such as the U.S. dollar

(Q) ___ exchange rates are determined by market forces; they vary against each other from one day to another

floating

(quiz) The exchange rate for converting the U.S. dollar into other currencies is continuously adjusted depending on the laws of supply and demand. This illustrates a ____ exchange rate

floating

(quiz) The World Bank's initial mission was to

help finance the building of Europe's economy by providing low-interest loans.

(Q) The ___ is a set of internationally agreed rules, conventions and supporting institutions, that facilitate international trade, cross border investment and generally the reallocation of capital between nation states

international monetary system

(Q) The IMF lends money to nations experiencing financial crisis in return for

macroeconomic policy implementation

(Q) When a country does NOT adopt a formal pegged rate, but tries to keep its currency within some range of a reference currency, a(n) ___ system exists

managed-float

(Q) The US directly lent money to European countries after WW2 through the ___ plan

marshall

pegged exchange rate

means the value of the currency is fixed relative to a reference currency, such as the U.S. dollar, and then the exchange rate between that currency and other currencies is determined by the reference currency exchange rate.

(Q) An argument against a fixed rate system is that this system limits countries' abilities to use ___ policy to expand or contract their economies

monetary

(Q) One argument for a floating exchange rate system is that a country regains control of its ___ policy

monetary

(quiz) Kussoko's currency, the Kussokan peso, is fixed relative to the U.S. dollar. As a result, the U.S. dollar exchange rate determines the exchange rate between the Kussokan peso and other currencies. This is an example of a ____ exchange rate.

pegged

(Q) The fixed exchange rate __ the growth of international trade and investment

promotes

The international monetary system

refers to the institutional arrangements that govern exchange rates.

(Q) By 2002, when foreign investors became less interested in US stocks and bonds, the inflow of money into the US

slowed down

(Q) Advocates of a fixed exchange rate contend that a fixed system will limit the destabilizing effects of

speculation

(quiz) A weakness of the Bretton Woods system was that it could not work if

the U.S. dollar was under speculative attack.

(Q) In 1987, the group of five met over concerns that ___ and the result was the creation of the louvre accord

the dollar might decline too far

fixed exchange rate

the values of a set of currencies are fixed against each other at some mutually agreed-on exchange rate

(Q) True or false: critics say that the experiences of South Korea and Iceland suggest that a floating exchange rate system can help a country recover from severe economic crisis

true

(Q) True or false: flexibility was an objective of the Bretton Woods agreement because it was recognized that a rigid policy of fixed exchange rates eventually would not work

true

Currency crisis

when a speculative attack on the exchange value of a currency results in a sharp depreciation in the value of the currency or forces authorities to expend large volumes of international currency reserves and sharply increase interest rates to defend the prevailing exchange rate

balance-of-trade equilibrium

when the income its residents earn from exports is equal to the money its residents pay to other countries for imports (the current account of its balance of payments is in balance)

(Q) Under the ___ system, if a country developed a permanent deficit by importing more than it exported, it would require the IMF to agree to currency devaluation

Bretton woods

(Q) The ___ agreement revised the IMF's articles of agreement and addressed floating exchange rates

Jamaica

managed float system or a dirty-float system

Other countries, while not adopting a formal pegged rate, try to hold the value of their currency within some range against an important reference currency such as the U.S. dollar or a "basket" of currencies.

gold standard

Pegging currencies to gold and guaranteeing convertibility

gold par value

The amount of a currency needed to purchase one ounce of gold

floating exchange rate

When the foreign exchange market determines the relative value of a currency

Banking crisis

a loss of confidence in the banking system that leads to a run on banks, as individuals and companies withdraw their deposits

Foreign debt crisis

a situation in which a country cannot service its foreign debt obligations, whether private-sector or government debt