Analysis of International Monetary Policy after the Euro Book - Essay Example

This fascinating book offers an extensive review of the impact of the introduction of the euro on the international monetary system. The dissect the impact of the euro on living standards in developed and developing countries, the growth of the euro zone, the role of the International Monetary Fund, and the function of gold in the international monetary system. Also discussed is the design of a new international financial architecture and its impact on the wealth of nations. The critique is frank, entertaining, and sometimes conflicting, empowering the reader to draw his or her own conclusions. Offering a comprehensive review, this book will have great appeal for economists, especially those working on international monetary policy and theory. Students will also find this book of value. The role of gold in the international monetary system This chapter of the book speaks about two important aspects. The first one being the importance of gold as a reference and as a reserve in the international monetary system and the second being the international monetary system and the fundamental reform as opposed to the traditional reform. Prior to the 1970s gold was the center of the International Monetary Fund. But since the late 1970s the IMF is trying to replace gold with SDR i.e. Special Drawing Funds at the center. SDR is a kind of settlement currency that has been created by the IMF. The image of gold in the official sector continued to change as there was a tremendous sale of gold by the various central banks. Market reports reported a loss statement claiming that all the central banks were selling gold which was actually not true (Robert A. Mundell, 2005). Actually, there were only six central banks in total that used to sell tremendous amounts of gold during the last decade. The six central banks which used to sell significant amount of gold were Belgium, the Netherlands, Australia, Argentina and Canada. The year 1999 experienced a real bombshell in the gold market which was totally unexpected. The reason for this unexpected development in the gold market was due to the announcement made by the Bank of England stating that it would sell the majority of the British gold in the next few years. This unexpected announcement made by the Bank of England hampered the gold price in the market as there was a strong suspicion in the minds of the people of what would happen in the future if the country of the old gold standard i.e. England starts selling all the gold. As an addition to this decision, the IMF also planned to sell some of its gold at the same time. This lead to the erosion of the gold prices in all the central banks those were present outside the United Kingdom. As a result of these major developments a very bearish outlook for gold has emerged in the market and market analysts started to feel that the entire amount of gold that was available would come into the market. This created a major concern to all the central bankers. As a result there were a lot of private meetings that were held and the IMF meeting that was held in Washington had a very important statement made. The statement which was made by the IMF was that there was a strong belief among the signatory central banks that gold would have an important role to play as a monetary asset in the future and this was a very important statement for central banks to use. Secondly, they have also stated that they would not enter the market as sellers of gold over the next five years. Another equally important statement was regarding the lending policy of the banks. The increase in the gold price during this period was also the result of the increase in the net lending of the gold by the central banks. After this price hike, the signatory central banks agreed upon a decision stating that they would freeze their lending operations of gold in the derivatives market. Though the United state was not part of this agreement for various legal reasons, they had an official policy of not to either sell or lend gold. This led to a decrease of 80-90 percent of official gold stock in the market except for already approved amount of gold. This led to a significant hike in the prices of the gold. Later, the government and the central banks together took certain actions to stabilize the market and also to calm down fears of huge central bank sales of gold. People generally do things out of self-interest and this is the fact on which economics is solely based upon. This fact additionally forms the basis of a free market economy. As stated above, the main issue that is being discussed in this paper is the role of gold in the international monetary system. In the Breton Woods System, the role of gold was very important. This system came to an end in the year 1971 as the United States did not have enough gold. This led to the evolution of the International Monetary Fund. The International Monetary Fund was established to ensure proper working of the international monetary system. One of the important functions of the IMF was to provide reserve credit to member countries facing temporary balance-of-payments problems. For this purpose, a currency pool according to its quota was fixed on the basis of each country’s importance in world trade. These contributions were to be partly in an international reserve currency’s domestic currency and partly in the country. Though under this system, the member countries had the option of pegging their currencies to either gold or to the dollar, the only reserve asset mentioned in the agreement establishing the system was gold. An appropriate example that can be quoted here is the pegging of Riyal, the currency of Saudi Arabia. The Saudis have been pegging the Riyal to the Dollar for years. One of the things that this requires is that the interest rates in the two countries remain the same; otherwise there are pressures for them to move relative to each other. The Saudis were not interested in following the recent Federal Reserve rates and this placed a further downward pressure on the U.S. dollar (Saroff, 2007 ). Recently, though there were issues regarding the de-pegging the Riyal from the depreciating Dollar the Saudi Arabian Monetary Agency ruled out the de-pegging of its currency (Saudi-US Relations Information Systems, 2008). However, as gold stocks did not increase substantially in the years following the agreement, this provision acted as an impediment to the growth of international trade (Robert A. Mundell, 2005). Fundamental reform of the international monetary system: necessity, timing and future directions This chapter’s main focus is – has the time for the fundamental reform of the international monetary system come? The various meetings that were held with the signatory banks and the IMF have resulted in numerous themes (Robert A. Mundell, 2005). But the first and foremost question is whether there is really a need for reforming the international monetary system. There are varied feelings about this particular question. Some feel that there is a systematic instability and in order to correct this instability a reform is very much necessary. There is another feeling that reforming the international monetary system would increase the efficiency of the system. The issue of efficiency comes in because of the different opinions that people have regarding the existence of even better system than the existing one and if so, would this lead to the evolution of the EU currency area as a new system. The second issue of concern here is the feasibility of the international monetary system with the given number of member countries. In the earlier chapter there were discussion regarding Europe, Japan and United states. Apart from these three countries there were many other countries the total of which is indeed large. Each country had its own perspectives and preferences with respect to the exchange rates and their choice. With all these in mind, the issue of feasibility of the international monetary fund is definitely an aspect that is to be remembered. Thirdly, provided there is a fundamental reform, will a common exchange rate regime be desired and accepted by all the countries? In case the answer is no for the above question, what is the alternative? The choice of exchange rate is equally important in order to maintain the stability of the international monetary system as it is important for all the countries that make the choice of the same. Above all, there is one final question which needs an answer. It is about the role of the International Monetary Fund. Is its role important in keeping the exchange rate system or is it confined only to other areas. These are the various proposals and perceptions about the role of the International Monetary Fund. The chapter also speaks about the instability of the current monetary system. The instability is with exchange rates between the Japanese yen, the US dollar and the euro. It has also been stated in the chapter that there exists instability in the international capital market with a fixed rate regime. The only solution to deal with this instability is to control it. There is also an alternate approach in dealing this instability. It is to accept the instability of the private sectors. This is something which has been quoted by John Maynard Keynes in the Keynesian economics. Apart from just accepting the instability, it is necessary that the IMF and the governments given a chance to cooperate and compensate the instabilities. There had also been a contrary view regarding the fact that the private sector is unstable. Manfred Neumann feels that the past 50 year history of the world monetary system has got enough evidence and reasons justifying this instability. The justification is that the instability is a result of the bad policies. The chapter also speaks about the emerging markets like Latin America and some other areas of the world which are having plans to form their own currency areas. The European Monetary Union has had a demonstrable effect (Robert A. Mundell, 2005). Towards the end of the chapter, there is a positive opinion about a fixed-exchange rate system. This is because of the concern regarding the price stability that most of the countries of the world has got. This becomes the primary concern also according to Keynes. The secondary concern is the exchange rate stability. It has been felt by many people that currency unification would have lots of benefits in the world trade. Choosing Exchange rate regimes: Lessons from Europe and Asia This chapter starts with the second Randall Hinshaw Memorial Lecture on the occasion of the fifteenth Bologna-Claremont Monetary Conference. This conference was started in the year 1967 by Randall, the fundraiser and editor of this series. The main issue that has been discussed as part of the conference was about a suitable exchange rate regime for emerging market, as they are called, that are developing rapidly (Robert A. Mundell, 2005). There are two alternatives for this. One is the currency boards or the monetary union on one hand and fixed exchange rates on the other hand. It is strongly felt that anything between fixed exchange rate and adjustable regimes cannot be agreed upon. With reference to this, there are a lot of discussions made about the East Asian Countries. There are a lot of lessons that can be learnt from those countries. The main focus would be especially on Asia rather than Latin America or any other country. There are three main objectives for the choice of the exchange rate regimes. The first one is the exchange rate stability. The implication underlying in this objective is that floating exchange rates create undue instability or “misalignments”. These are factors that have adverse effects over international trade and capital movements. The European Monetary System, in its early stages during 1983 was governed by this objective. The second objective is the real targets approach which sees the use of nominal exchange rate as a policy instrument. The third objective is the nominal anchor approach which is designed to anchor a country’s inflation rate by fixing the exchange rate. As stated earlier, the main focus of this chapter is on the East Asian Countries, especially Asia and in particular Thailand. This is because the Asian Economic Crisis first originated there. Until the crisis in the year 1997, the Thai baht was effectively being pegged with the US dollar. This pegging of the Thailand baht with the US dollar dates back to somewhere around 1954. There occurred only two modes devaluations in 1954 and 1997 respectively. Hence, it can be stated that there is a long fixed exchange rate history. Thailand also experienced a boom which was essentially an investment boom partially financed by foreign capital and it began in 1987 and lasted till 1997. During this period the average per capita income growth was almost 8 percent and this was one of the highest in the world. Such a boom was bound to come to an end provided the central banks are committed to the fixed exchange rate. A currency board system was felt as another alternative for Thailand. The favorable and interesting part about a fixed exchange board system for Thailand was it would have avoided the sharp depreciation that occurred in between 1997 and 1998. The second country that is relevant for this discussion is Indonesia. Before the crisis, Indonesia had a crawling peg with a band. When speculation against the rupiah pushed the currency to the bottom of the band, the exchange rate was quickly floated. There were no attempts made to hold the rate, and hence fruitless foreign exchange losses were not incurred. This was believed to be a perfectly sensible exchange rate policy according to the economic situation. Finally, it can be concluded by saying that “No single currency regime is right for all countries at all times” and this was quoted in a Princeton essay by Jeffrey Frankel. The conference was concluded by coming to an opinion that a flexible peg regime was the best alternative. This is a clear lesson from that can be learn from the five East Asian countries that were affected by the crisis especially from Thailand and Indonesia. Bibliography 1. Robert A. Mundell, P. J. (2005). International Monetary Policy after the Euro. Northampton: Edward Elgar. 2. Saroff, M. (2007 , September 20). Saudis appear to drop Dollar Peg on Riyal. Retrieved March 22, 2008, from Blogspot.com: http://40yrs.blogspot.com/2007/09/saudis-appear-to-drop-dollar-peg-on.html 3. Saudi-US Relations Information Systems. (2008, February 26). Dollars and Riyals: Floating Currencies. Retrieved March 22, 2008, from Saudi-US Relations Information Systems: http://www.saudi-us-relations.org/articles/2008/ioi/080226-dollar-peg.html Read More