Money provides innumerable benefits in our day-to-day lives. In the classical theory, money played an insignificant role as it had no causative influence on the economy. In the opinion of classical theorists, money was purely confined to medium of exchange and related itself to economic activity.
Money was used as a technical instrument to overcome the complexities involved in barter system. There was strong opinion that money was a passive element, which was used to help in the process of exchange. Contrary to this, in modern economics money plays a significant and an active role. Modern economists emphasize that the most important function of money is to regulate the general economic activity and to promote the wealth and welfare of a country's economy. It further explains how money influences production, consumption and distribution. Thus, the institution of money is considered to be an efficient instrument contributing to economic prosperity of a country.
Due to the advent of globalization, financial markets are getting integrated with the passage of time, and people and firms are entering into more and more cross-border financial deals. In order to make these transactions feasible, a system for determination of the amount and method of payment of the underlying financial flows is needed. Since the domestic currencies of the parties involved will be different, the flows will take place in some mutually acceptable currency. The parties involved will then need to convert the amount involved into their domestic currencies. The set of rules, regulations, institutions, procedures, practices and mechanisms which determine the rate at which this conversion takes place and this rate of conversion is defined as the Exchange rate and the movements in the exchange rate over a period is called the international monetary system. This system forms the backbone of all cross-border transactions because it makes the settlement of international payments into one another and the transfer of funds across nations, which becomes possible due to the existence of the international monetary system. These transactions may be on account of international trade in goods or service, or due to acquisition or liquidation of financial assets, or because of creation or repayment of international credit. By making all these possible, a smoothly running international monetary system contribute to a more efficient utilization of world resources.
The Bretton Woods Fixed Exchange Rate System
The Second World War effectively stopped all international economic activity. Global economic growth was severely affected. On one hand, the warning nations suffered huge damages on account of the war, and on the other hand, most of the countries were suffering from hyper-inflation ((ICMR), 2003). The continuing war also made any co-operation on the economic front impossible. In this scenario, the need was felt for an economic system which would again make international