international monetary system

Opportunities for the World Bank

Although it has many critics, the World Bank has many opportunities for enhancing its role in the world. Let's look at some of these opportunities. Improving global competitiveness: The World Bank acts as a strong trade catalyst for some countries. Such countries are able to use the Bank's know-how and financial expertise to improve their global competitive position. For example, many African nations have improved their exports or some of their domestic industries with the World Bank's support. Increasing transparency: In response to critics, the World Bank has opened up its process of evaluation and making decisions. The Bank's officials continue to set high standards. They deal firmly with cases of corruption, be it with member countries, or its own people and processes. Showing sensitivity to gender issues: The World Bank modified its policy to increase sensitivity to gender issues in 2001. The new policy recognizes that women are affected differently by poverty, compared to men. All development project evaluations now include clauses that examine the impact on women and men differently.

Opportunities for the IMF

Although the IMF faces many challenges, it also has many opportunities for enhancing its role in the world. Flexibility and speed: The IMF has programs to make funds available quickly to certain qualified member countries. For example, under the Flexible Credit Line (FCL), countries are assessed for good macroeconomic records, rather than their promises. Another program, the Rapid Credit Facility, aims to help countries with low income levels. Both of these programs offer easy payout options and impose few conditions. Reassuring members: The IMF provides loans to some members for support and reassurance. The aim is to earn goodwill, and to promote political and economic stability. Adapting to needs: IMF loans are tailored to the needs of members. For example, in developing economies, short-term loans are offered to governments. These loans help them win the confidence of investors. Aiming for transparency: The IMF aims to create fair policies for all members. It makes all its dealings transparent as far as possible. This is intended to prevent any member with strong influence from becoming dominant. However, large economies continue to have more influence on the IMF's policy-making.

Fixed Exchange Rate System

In a fixed exchange rate system, the government fixes, or 'pegs' the country's currency value to another country's currency. Up to 1973, most countries pegged their currency values to the value of the US dollar, which was pegged to the price of gold. After 1973, most countries have abandoned the fixed exchange rate system. Let's look at some of the advantages of a fixed exchange rate system. Promotes international trade: Fixed exchange rates help stabilize trade dealings and boost the confidence of exporters and importers. With foreign payments assured at a specific rate of exchange, it allows global trade to grow. Necessary for small nations: For smaller nations such as Belgium and Denmark, foreign trade plays a critical role. Fixed exchange rates support the growth of such economies by providing a reliable base for long-term fiscal planning. Promotes international investment: Investors and money lenders are willing to provide loans against fixed exchange rates. This is because they get an assured value for their investment if the exchange rates are fixed. Therefore, the international investment community is very supportive. Removes speculation: Fixed exchange rates keep out speculative dealings. Speculative traders will not be tempted to shift large sums of money from one country to another. Necessary for developing countries: Developing economies stand to gain from fixed exchange rates. They can keep away speculators and persuade investors to put their money into long-term development projects with assured returns.

Floating Exchange Rate System

In a floating exchange rate system, the value of a currency is based on market conditions. These conditions vary with the supply of goods and services produced and sold by the country. Let's look at some of the advantages of a floating exchange rate system. Creates independence: A country that uses a floating exchange rate is free to set its own monetary policies. Its monetary policy is not held down by the price of gold or another country's currency value. Fluctuations in international currency values are no longer limiting conditions. Absorbs shocks: A floating exchange rate system can readily buffer a country's economy from sudden variations in other economies. Therefore, it helps in the smooth management of the country's domestic finances and projects. Promotes economic development: A floating exchange rate system enables strong economic growth. Exchange rates can be changed to match monetary policy changes. This flexibility helps generate full employment, and provides an impetus to overall growth and stability. Solves balance of payment problems: In a floating exchange rate system, all imbalances in the balance of payments get corrected automatically. For example, if there is a deficit in the balance of payments, the total value of imports exceeds the total value of exports. In this situation, the external value of the country's currency drops automatically-it becomes devalued. The imbalance is corrected because the new exchange value will encourage exports and discourage imports. Promotes international trade: Floating exchange rates enable free trade, or the unrestricted movement of money and capital between economies. International trade becomes easier. Countries become more cooperative in doing business across borders. Helps lower reserves: The floating exchange rates system enables countries to maintain lower stocks of foreign exchange reserves. This also helps to improve the international liquidity of currency, and thereby boosts global trade and business.

Although floating exchange rate systems are used by most of the world's economies, they have several disadvantages. Let's look at some of them.

Low elasticities: In some cases, the demand for exports and imports may be inelastic. This means that buyers don't buy exported goods even if they are offered at a lower cost. At the same time, importers don't cut imports, even though it costs them more. In such a situation, a floating exchange rate will not help restore any imbalance in the balance of payments. The devalued currency may make the balance of payments deficit even more acute. Unstable conditions: Floating exchange rates often produce unstable conditions. Traders and investors generally avoid long-term investments if they feel that the conditions are too risky. Adverse effects: High variations in foreign exchange rates can adversely affect a country's economy. If traders and investors leave the market, the economy will not grow. Unnecessary capital movements: Frequent changes in exchange rates may attract speculators. Speculative activities typically cause large inflows or outflows of capital from an economy. These large-scale shifts can destabilize a healthy economy.

Exchange Rates

One of the important roles of the IMF is to promote exchange rate stability. The exchange rate is the price for which one country's currency can be exchanged for that of another country's currency. Exchange rates can be of two main types: fixed or floating. In a fixed exchange rate system, the value of a country's currency is held at a fixed conversion rate, as compared to the value of other currencies. In a floating exchange rate system, the value of a currency is based on market conditions. These conditions vary with the supply of goods and services produced and sold by the country. In practice, many countries tend to adapt a flexible approach between these two systems, based on the needs of their economic situations. For example, many economies use an approach called the managed floating rate system. In this system, the central bank actively intervenes by holding stocks of currency and trading in international currency values. Let's look at the different types of exchange rate systems in more detail.

Although fixed exchange rate systems are used by some of the world's economies, they are largely outmoded, and have some disadvantages. Let's look at them.

Outmoded system: The fixed exchange rates system was a workable solution in the nineteenth century when the gold standard was adopted by many countries. The monetary policies of these countries were coordinated. Today, the gold standard is no longer used by any country, and these conditions are not relevant. Monetary dependence: Countries using the fixed exchange system lose the freedom to decide monetary policies in the best interest of their growth. Rather, they are compelled to shrink or expand their money supply to maintain stability in the international market.

Challenges to the World Bank

Some observers criticize the World Bank for several reasons. Let's look at some of the challenges that the World Bank faces. Fostering incompetence: According to critics, the World Bank has been shifting focus. It has become a global welfare organization, and moved away from being a lending bank of last resort. This shift has created an overstaffing situation, and administrative incompetence. Supporting inefficient countries: Critics claim the Bank has supported inefficient practices in many underdeveloped countries. Critics contrast the high growth of East Asian economies with the poor growth of African countries aided by the World Bank. Asian countries, such as South Korea, have overcome poverty by investing in macroeconomic reforms with little help from the World Bank. African countries, such as Nigeria, have become dependent on World Bank (and other) support organizations. These countries have become inefficient or corrupt. They have avoided the fundamental reforms that could have ended poverty. Allowing G7 countries to dominate: The G7 countries include all the large industrialized economies. Some critics suggest that most World Bank decisions and policies are strongly influenced by the members of these countries. Many of these policies are not useful for developing economies. Focusing on large projects: Critics point out that the World Bank often backs large-scale projects such as dams, rather than providing basic support for the poor. These projects affect the environment and often damage natural resources such as rivers and forests. They also displace thousands of people from their traditional habitats. For example, in Brazil, the Polonoroeste development program has caused massive deforestation in the region's tropical forest. Influencing policies negatively: The World Bank has a lot of influence on policies, research, and applied practices in development projects. Critics point out that the Bank's dominant role may shut out all other approaches to development.

The IMF uses three main tools to support its goals. These are: surveillance, technical aid and training, and lending.

Surveillance: The IMF encourages member countries to use effective financial and economic policies. It conducts reviews of national and global developments affecting each country. It also weighs the impact of policy changes of each country on other economies. This process is called bilateral surveillance. It also does an overall analysis of regional and global economic trends. This process is called multilateral surveillance. Surveillance, as used in this context, does not mean 'secret watching'-it is an open process of review and analysis. Technical aid and training: The IMF provides technical support and training to member countries to enable them to create and use effective policies. It offers technical aid and training in four areas: financial and monetary policies; fiscal policy and management; management of statistical data; and financial and economic legislation. Lending: The IMF provides financial loans and helps member countries to create a policy framework to tackle balance of payments problems. To continue getting financial aid, members must implement the suggested policies.

Challenges to the IMF

The IMF has been criticized for many reasons. Let's look at some of the challenges that the IMF faces. Imposing economic conditions on loans: The IMF adds many conditions before it offers a loan. The borrowing country is expected to implement several stringent economic policies. For example, the member may be asked to do the following: - Impose higher taxes and reduce spending. - Let poorly performing companies go bankrupt. - Charge higher interest rates. - Reduce bureaucracy and corruption. - Introduce deregulation or privatization. These policies may benefit the IMF. However, they could cause political hardships to the average citizens of member countries. Encouraging corruption: In some cases, the IMF's conditions can set off unintended consequences. For example, in Kenya, the IMF asked for removal of controls on the movement of capital. This move was part of an exchange rates reform proposal. It enabled some corrupt people to shift money illegally out of the country. Some critics say that such cases indicate that the IMF does not have a realistic understanding of their member countries. Supporting military dictatorships: In some cases, the IMF has been criticized for backing military dictators in member countries. For example, the IMF supported General Augusto Pinochet in Chile, Anastasio Somoza in Nicaragua, Mobutu in Zaire, and Ceaucescu in Romania. Allowing inflationary devaluations: In some cases, the IMF has allowed monetary devaluation to increase demand for domestic products in some countries. Such measures often lead to inflation and several economic problems for the member country. Influencing free market economics: According to supporters of free market economics, the IMF's moves to influence exchange rates are not desirable. They argue that currencies must be left free to find their own market levels. Moreover, they oppose the IMF's bailouts of countries in debt. Bailouts would encourage debt-ridden countries to spend recklessly. Lacking transparency: According to some critics, the IMF often does not consult affected members before imposing policy decisions.

International Monetary Fund

The International Monetary Fund (IMF) is a global organization. It is a collaboration of several countries to ensure financial stability worldwide. Let's look at the goals of the IMF in detail. Supporting global cooperation: The IMF works as a stable world institution. It helps resolve monetary problems. It also promotes global cooperation among the member countries. Enabling expansion of global trade: The IMF aims to support the balanced expansion of international trade. All IMF members gain higher income levels and employment opportunities. Their productive resources are also put to full use. Maintaining exchange stability: IMF members benefit from a stable system of monetary exchange. This system keeps out unhealthy competition that could create depreciation battles. Removing foreign exchange restrictions: The IMF's multilateral payment system helps members manage transactions efficiently. The system also helps promote trade growth by removing foreign exchange restrictions. Providing temporary funds: IMF members can avail themselves of a variety of loans. These loans are temporary, but they help members correct deficiencies in their balance of payments.

The World Bank

The World Bank is a global financial organization. Its main role is to finance the growth and development of the poorest economies. Let's look at some of the World Bank's developmental goals in detail. Helping the poorest people: The World Bank aims to reduce poverty and provide resources for sustainable growth in countries that are home to the world's poorest people. Africa has a large number of such countries. Helping conflict-ridden countries: Many countries such as Sri Lanka, Afghanistan, and Rwanda are affected by internal conflicts. Their governing bodies, political systems, and institutions are weak. The World Bank aims to help develop stability in such countries. Helping middle-income countries: The World Bank defines middle-income countries (MICs) as one of the income groups. As of 2012, MICs were those countries with a per-capita gross national income (GNI) between $1,036 and $12,615. MICs are offered finances and customized solutions for development projects. Helping the Arab world: The Arab world includes 22 countries in the Middle East and Africa. They face many special challenges, such as income and gender inequalities and conflicts. The World Bank works to improve conditions for financial inclusion and education in such regions. Providing global public support: The World Bank also supports member countries to help to deal with global problems such as infectious diseases and the effects of climate change. These problems contribute to the persistence of extreme poverty. They increase the financial burden on poor countries. Providing knowledge and learning: The World Bank offers education finance support to needy countries. It also offers educational knowledge products that can be accessed for free by members.

The Common European Currency

The euro is an example of how a common currency can help in stabilizing exchange rates. The euro is used as a single currency by 19 of the 28 members of the European Union (EU). These 19 states are called the eurozone. Let's look at the positive impact the common currency has had on the eurozone. Eliminating conversion costs: The euro eliminated the cost of conversion from one currency to another. This has helped both domestic travelers and tourists. They can travel economically and transact for goods and services all over the eurozone (countries where the euro is a valid currency). Transparent pricing: The euro allows quick comparisons of prices across the eurozone. Businesses can procure goods, and shoppers can buy goods for the best prices. Another benefit for buyers is that prices of many common goods, such as cars, have become competitive across the eurozone. Removing exchange rate variations: A single currency eliminates unpredictable swings in exchange rates, which is common with multiple currencies. This gives a boost to trading and business activities in the eurozone. Improvement in inflation performance: The European Central Bank (ECB) decides common interest rates for all countries in the Eurozone. It creates policies for controlling inflation. Therefore, EU countries can all benefit from these shared financial services. Attracting investment: Companies in countries outside the EU benefit from lower costs of business transactions inside the EU. This would also attract more business investments into the eurozone. Although the euro offers many benefits to its members, and to other trading countries, it is also associated with many problems. Let's look at some of these problems. Not suitable for all: In some cases, a common interest rate decided by the ECB may not work for an EU member. If the ECB increases interest rates to help one country that is affected by inflation, the higher interest rate may be unsuitable for others who are going through a recession. Differences in debt handling: A uniform monetary policy can work well only if the member countries have comparable levels of debt. A country in the EU that has run up a high level of national debt, such as Greece, may not be able to get sufficient buyers. Members become complacent: A common euro offers all EU members protection against a currency crisis. However, it also leads to complacency. For example, Greece took advantage of low yields on bonds for many years, expecting support from others in the eurozone. This led to the Greece crisis of 2016.

Managed Floating Rate System

The floating rate system is followed by most countries in the world. However, in many cases, free market forces create wild swings in a floating rate system. There may be large outflows and inflows of excess money. In such cases, the central bank sometimes steps in to correct imbalances. It infuses or removes large volumes of currency to balance the economy. This arrangement is called a 'managed' floating rate system. Let's look at some of the features of a managed floating rate system. - The managed floating rate has features of both the fixed and the floating rate systems. It is also called 'dirty' floating. - The central bank of a country acts to restrain the wild swings within a managed range. The frequency of such interventions varies for different economies. - The central bank typically keeps a reserve stock of foreign exchange to tide over periods of wild swings. According to a survey by the IMF, 82 countries used a managed exchange rate system in 2013. This represents 43 percent of all countries. China is one of the major users of the managed floating rate system.