Briefly explain the flexible exchange rate regime Bring out the recent developments in Indian Monetary System?

Answer 1

International monetary systems are sets of internationally agreed rules, conventions and supporting institutions that facilitate international trade, cross border investment and generally the reallocation of capital between nation states. They provide means of payment acceptable between buyers and sellers of different nationality, including deferred payment. To operate successfully, they need to inspire confidence, to provide sufficient liquidity for fluctuating levels of trade and to provide means by which global imbalances can be corrected. The systems can grow organically as the collective result of numerous individual agreements between international economic actors spread over several decades.

British and American policy makers began to plan the post war international monetary system in the early 1940s. The objective was to create an order that combined the benefits of an integrated and relatively liberal international system with the freedom for governments to pursue domestic policies aimed at promoting full employment and social wellbeing. The principal architects of the new system, John Maynard Keynes and Harry Dexter White, created a plan which was endorsed by the 42 countries attending the 1944 Bretton Woods conference. The plan involved nations agreeing to a system of fixed but adjustable exchange rates where the currencies were pegged against the dollar, with the dollar itself convertible into gold. So in effect this was a gold - dollar exchange standard. There were a number of improvements on the old gold standard. Two international institutions, the International Monetary Fund (IMF) and the World Bank were created; A key part of their function was to replace private finance as more reliable source of lending for investment projects in developing states. At the time the soon to be defeated powers of Germany and Japan were envisaged as states soon to be in need of such development, and there was a desire from both the US and Britain not to see the defeated powers saddled with punitive sanctions that would inflict lasting pain on future generations. The new exchange rate system allowed countries facing economic hardship to devalue their currencies by up to 10% against the dollar (more if approved by the IMF) - thus they would not be forced to undergo deflation to stay in the gold standard. A system of capital controls was introduced to protect countries from the damaging effects of capital flight and to allow countries to pursue independent macro economic policies while still welcoming flows intended for productive investment. Keynes had argued against the dollar having such a central role in the monetary system, and suggested an international currency called bancor be used instead, but he was overruled by the Americans. Towards the end of the Bretton Woods era, the central role of the dollar became a problem as international demand eventually forced the US to run a persistent trade deficit, which undermined confidence in the dollar. This, together with the emergence of a parallel market for gold where the price soared above the official US mandated price, led to speculators running down the US gold reserves. Even when convertibility was restricted to nations only, some, notably France continued building up hoards of gold at the expense of the US. Eventually these pressures caused President Nixon to end all convertibility into gold on 15 August 1971. This event marked the effective end of the Bretton Woods systems; attempts were made to find other mechanisms to preserve the fixed exchange rates over the next few years, but they were not successful, resulting in a system of floating exchange rates

· Differentiate the features of past exchange system and present exchange system.

Countries of the world have been exchanging goods and services amongst themselves. This has been going on from time; immemorial. The world has come a long way from the days of barter trade. With the invention of money the figures and problems of barter trade have disappeared. The barter trade has given way ton exchanged of goods and services for currencies instead of goods and services.

Different countries have adopted different exchange rate system at different time. The following are some of the exchange rate system followed by various countries:

A. The Gold Standard

Many countries have adopted gold standard as their monetary system during the last two decades of the 19th century. This system was in vogue till the outbreak of World War 1. Under this system the parties of currencies were fixed in terms of gold. There were two main types of gold standard:

1. Gold specie standard: Gold was recognized as means of international settlement for receipts and payments amongst countries. Gold coins were an accepted mode of payment and medium; of exchange in domestic market also. A country was stated to be on gold standard if the following condition were satisfied:

1. Monetary authority, generally the central bank of the country, guaranteed to buy and sell gold in unrestricted amounts at the fixed price.
2. Melting gold including gold coins, and putting it to different uses was freely allowed.
3. Import and export of gold was freely allowed.
4. The total money supply in the country was determined by the quantum; of gold available for monetary purpose.

2. Gold Bullion Standard: Under this system, money in circulation was either partly of entirely paper and gold served as reserve asset for the money supply. However, par money could be exchanged for gold at any time. As the monetary authorities did not aspect all the paper currency to be converted into gold, there was no need or they to hold gold for covering money supply in full.

The exchange was determined by the gold content of the respective currency. E.g. if the gold content in Britain was 3 times US, then automatically pound sterling(GBP) was equivalent of 3 US dollars. This system is also known as 'Mini Parity Theory'. After World War 1, all European gold standard countries left in 1936, thus the gold standard era was effectively over.

B. The Bretton Woods System

The bitter experience of war year, and danger of the recurrence looming large, forced the countries to create a free, stable and multilateral money system, which would help in restoration of international trade. As early as in 1943 USA and Great Britain accepted at the Bretton Woods Conference held in July 1944 and International Monetary Fund (IMF) was established in 1946.

In this system the member countries require to fix the parities of their currencies in terms US dollar or gold with fluctuations in their currency within 1% of limit. Due to massive deficit increased the supply of US dollar in international market and gold reserve held by USA were not sufficient to cover.

Through the Smithsonian Agreement, USA devalued dollar from 35 ounce to 38 per ounce, but could not last long.

The concept of one single currency of entire European was accepted way back in 1991 under Maastricht Treaty, and has come into reality effective January 4 1999 and the currency now has established independent currency since January 2001.

C. Purchasing Power Parity (PPP)

Professor Gustav Cassel, a Swedish economist, introduced this system. The theory, to put in simple terms states that currencies are valued for what they can buy. Thus if 135 JPY buy a fountain pen and the same fountain pen can be bought for USD 1, it can be inferred that since 1 USD or 135 JPY can buy the same fountain pen, there fore USD 1 = JPY 135.

For example if country A had a higher rate of inflation as compared to country A then goods produced in country A would become costlier as compared to goods produced in country B. This would induce imports in to country A and also the goods produced in country A being costlier, would lose in international competition to goods produced in country B. This decrease in exports of country A as compared to exports from country B would lead to demand for the currency of country B and excess supply of currency of country A. This in turn, causes currency of country A to depreciate in comparison of currency of country B which is having relatively more exports.

After the collapse of PPP system there came the Bretton woods System, and after the collapse of that Smithsonian Agreement. At present the floating rate system is used in all most countries.