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Sem 5 Prep
← Open Economy MacroWhat an international monetary system is

Formulas for this chapter

The three evaluation criteria

Adjustment = how BoP disequilibria are corrected: quickly and at low cost Liquidity = reserve assets available to settle TEMPORARY disequilibria Confidence = belief the mechanism works and reserves keep their absolute and relative values

Any question asking you to evaluate a system, past or present. Take the three in order and give a verdict on each.

Adjustment
The process criterion. Fails when correction is slow or bought with unemployment and inflation
Liquidity
The stock criterion. Fails when reserves are too small for a nation to avoid deflating
Confidence
The belief criterion. Fails when reserve assets are doubted or a devaluation is expected

Measuring the three criteria

Adjustment cost = deficit / MPM (income given up; ratio is 1/MPM) Policy cut = (deficit / MPM) / k (autonomous spending to cut) Import cover = reserves / monthly imports Years financed = reserves / annual deficit Backing ratio = convertible asset / foreign-held claims

Whenever a question hands you figures and asks how well a nation or a system is placed. These are our measures, so state the formula you used.

1/MPM
Units of income destroyed per unit of deficit closed. 6.67 at MPM = 0.15, 20 at MPM = 0.05
import cover
Months of imports payable from reserves. Three months is the usual minimum benchmark
backing ratio
Share of foreign claims that could actually be converted. Falls mechanically as claims grow

The two classifications

By exchange rate mechanism: fixed | flexible | hybrid (managed float, adjustable peg, crawling peg, currency board, dollarisation) By reserve asset: gold standard | gold-exchange standard | fiat standard

Describing any historical or present regime. Give one answer on each axis; the axes are independent.

gold standard 1880-1914
Fixed rates, gold reserves
Bretton Woods 1947-1971
Adjustable peg, gold-exchange standard
today
Managed float, fiat standard
Step 3 of 22
The real wordsTheory

What a good system achieves

The deck gives two objectives, and only two.

  1. It maximises the flow of international trade and investment.
  2. It leads to an equitable distribution of the gains from trade among nations.

Notice that neither objective is stability of exchange rates for its own sake. A rigidly stable rate that chokes trade or hands all the gains to one country fails both tests.

The second objective is the one that makes IMF conditionality and the dollar's privileges arguable rather than technical.

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