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Sem 5 Prep
← Open Economy MacroThe present international monetary system

Formulas for this chapter

Reserve composition

share of a category = category / total reserves Total = foreign exchange + gold + SDRs + reserve position in the IMF Rebalancing at a fixed total: target holding = target share x total

Any question on the composition of reserves or on dedollarisation. Compute the total first, and remember that a fixed total makes a target share a computable level.

foreign exchange
Typically around 80 per cent of the total, mostly dollars: the mark of a fiat standard
SDRs
The IMF's own reserve asset, a basket of major currencies

Misalignment against purchasing power parity

PPP rate = base rate x (home price index / foreign price index) misalignment % = (market rate - PPP rate) / PPP rate market rate above PPP => home currency UNDERvalued market rate below PPP => home currency OVERvalued

Sizing the misalignment the deck complains about. Say that PPP is a long-run benchmark that ignores non-traded goods and productivity differences, so a gap is evidence rather than proof.

base rate
The rate in the year when the two price indices were equal
direction check
Faster home inflation means more home units per dollar, so the PPP rate must rise

Volatility, crudely measured

range % = (highest rate - lowest rate) / mean rate x 100

Putting a number on short-run exchange rate movement. Contrast it with the misalignment figure: volatility is hedgeable, a wrong level is not.

range
High minus low over the period
mean
The average of the observations, the denominator

Substitution account arithmetic

backing ratio = reserve assets / foreign-held claims after converting C: new ratio = reserve assets / (claims - C) To reach a target ratio r: C = claims - (reserve assets / r)

The SDR substitution account question. The reserve assets never change: the account works entirely on the denominator, which is why the interest and buyback questions killed it.

C
The amount of dollar claims converted into SDRs
the two objections
Who pays or earns interest on the converted SDRs, and when the United States buys the dollars back
Step 3 of 26
The real wordsTheory

Who floats and who does not

The notes count them. 81 nations opted for a managed float, including many industrial nations and the large developing nations, India among them.

The remainder chose one of three harder commitments.

  • Dollarisation: abandoning the national currency and using the dollar.
  • A currency board: issuing domestic money only against foreign reserves, at a fixed rate.
  • A peg: fixing to a currency or a basket.

All of them, floaters included, need international reserves to intervene in exchange markets. Floating did not abolish reserves.

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