2.2 Evolution of international monetary systems

International monetary systems have evolved dramatically over time, shaping global finance. From the Gold Standard's fixed rates to Bretton Woods' dollar-based system, each era brought unique challenges and opportunities for trade and economic stability.

The shift to floating exchange rates marked a pivotal change, giving countries more control over monetary policy. While this increased flexibility, it also introduced new complexities in managing currency values and international economic relationships.

Historical Development of International Monetary Systems

Evolution of monetary systems

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• Gold Standard (1870s-1914) established fixed exchange rates with currencies backed by gold reserves facilitated international trade
  • Countries maintained specific gold-to-currency ratios (US $20.67 per ounce)
  • Limited money supply growth constrained by gold production
• Interwar Period (1918-1939) saw attempts to revive gold standard disrupted by economic instability
  • Great Depression triggered bank failures and currency devaluations
  • Countries abandoned gold standard to pursue independent monetary policies
• Bretton Woods System (1944-1971) introduced fixed but adjustable exchange rates with US dollar as reserve currency
  • Allowed 1% fluctuation band around par values
  • IMF provided support for temporary balance of payments issues
• Post-Bretton Woods Era (1971-present) shifted to floating exchange rates and regional monetary cooperation
  • Managed float systems combine market forces with occasional central bank intervention
  • Currency unions emerged (Euro) to enhance economic integration

Bretton Woods system impact

• Established in 1944 at conference in New Hampshire created framework for post-war monetary cooperation
• Key features reshaped global finance:
  • Fixed exchange rates with 1% fluctuation band promoted stability
  • US dollar pegged to gold at $35 per ounce anchored system
  • Other currencies pegged to US dollar created network of stable exchange rates
• International Monetary Fund (IMF) creation provided short-term loans to countries facing balance of payments difficulties
• World Bank establishment focused on long-term economic development and reconstruction
• Promoted international trade by reducing exchange rate uncertainty
• Facilitated post-war economic recovery through stable monetary environment

Transition to Floating Exchange Rates

Collapse of Bretton Woods

• Triffin Dilemma exposed inherent contradiction between national monetary policy and global reserve currency role
  • Required US to run balance of payments deficits to supply dollars
  • Undermined confidence in dollar's gold backing
• US balance of payments deficits accumulated as foreign dollar holdings grew
• Inflation pressures in the United States eroded dollar's purchasing power
• Speculative attacks on the US dollar intensified as confidence waned
• Nixon Shock (1971) suspended dollar's convertibility to gold ended Bretton Woods
• Smithsonian Agreement (1971) attempted to salvage fixed exchange rate system by adjusting parities
• Jamaica Agreement (1976) formalized floating exchange rate system and demonetized gold

Comparison of monetary systems

• Gold Standard
  • Advantages: Price stability across countries and automatic balance of payments adjustment
  • Disadvantages: Limited monetary policy flexibility to address domestic economic issues
• Bretton Woods System
  • Advantages: Stability in exchange rates fostered international trade and investment
  • Disadvantages: Asymmetry in adjustment pressures (deficit vs. surplus countries)
• Floating Exchange Rates
  • Advantages: Monetary policy independence allows tailored responses to economic conditions
  • Disadvantages: Exchange rate volatility can create uncertainty for businesses
• Managed Float
  • Advantages: Flexibility with some stability through occasional intervention
  • Disadvantages: Potential for conflicting policy objectives (exchange rate vs. domestic goals)