International Monetary System: Role, Types and UGC NET Notes

International Monetary system constitute the framework that eventually regulates all financial interactions among members of the international community. It creates a mesh that enables international trade, the movement of capital, and the transferring of currencies. The international monetary system provides for all the rules, institutions, and conventions that make it possible for countries to transact with one another and manage their economies in an interconnected world.The international monetary system acts as the backbone of global financial stability. . The international monetary system refers to the guide of money, policies, institutions, and deals that help global trade and finance. The international monetary system allows nations to trade goods and services with each other as well as make financial investments across borders. At its core, the system has other money and exchange rates that help trade among nations. The international monetary system allows global trade and investments by giving a guide of money, exchange rates, central banks, and global institutions mixing economic policies across borders. The stability and efficacy of this system are crucial for helping bearable growth in the global economy.

The International Monetary System is a precise topic in the UGC-NET Commerce Examination.

In this article, the learners will be able to learn about the international monetary system in detail, along with its functions, essence, functions, types, etc.

In this article, learners will know about the following:-

• What Do You Mean by International Monetary System?
• Evolution of International Monetary System
• Timeline of International Monetary System Evolution
• History of the International Monetary System
• Features of International Monetary System
• Functions of International Monetary System
• Importance of International Monetary System
• Types of International Monetary System
• Comparison of Fixed vs Floating Exchange Rate Systems
• Criteria for Good International Monetary System
• Evaluation of International Monetary System

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What Do You Mean by International Monetary System?

The international monetary system gives the set for global trade and financial trade among nations. It aims to boost the orderly exchange of goods, services, and investments across borders.A key aspect of the international monetary system is its ability to facilitate the smooth exchange of currencies

At its core, the system consists of currencies and exchange rates that help trade among nations. Each nation's currency acts as a mode of exchange in global trade. The exchange rate among currencies defines how much one currency is worth in terms of another.

Central banks play an vital role by working monetary policies and exchange rates within their distinct economies. They work to maintain price stability and a healthy financial system. Global institutions like the IMF and World Bank foster international monetary system and financially assist nations when ought.

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Fig: international monetary system

The international monetary system has evolved through several specific periods, such as the gold standard, Bretton Woods system, and the currently floating exchange rates. Each period represents changes in the global economy and the dictates for monetary stability. The history of the international monetary system has grown to adapt to going global economic conditions, as stated below.

• The Classical Gold Standard (1870 - 1914): During this period, the international monetary system was based on the gold standard, where currencies were pegged to gold at a fixed rate. This system gives strength but lacked flexibility. It tumbled during World War I.
• Interwar Years (1920 - 1944): After World War I, many nations abandoned the gold standard and focused on domestic economic needs. Competitive depreciation and trade barriers raised. There was little international monetary cooperation.
• Bretton Woods System (1945 - 1973): The IMF and World Bank were set at Bretton Woods to foster global monetary stability and reconstruction. A quasi-gold ideal with the US dollar as a reserve currency was enforced. But the system broke down due to payments imbalances and US dollar devaluations.
• Floating Exchange Rates (1973 - Onwards): Most major currencies traded to a floating exchange rate system where currency values were defined by market demand and supply. This gives more flexibility but raised exchange rate volatility. There is an exchange rate risk involved.
• Post-Bretton Woods System: The IMF and World Bank resumed to play vital roles. Grown globalization, trade liberalization, and financial creations have shaped the modern international monetary system. However, there remain calls for reforms to bear financial flux and global economic imbalances.

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Timeline of International Monetary System Evolution

Among the important dates for the IMS is the period of a classical gold standard (1870s), the Bretton Woods Agreement (1944), the end of fixed-exchange rates (1971), and the present one of flexible rates. Each of these time periods has changed world finance and monetary cooperation. The time line of international monetary system is stated below:- 

History of the International Monetary System

The history of IMS covers how exchange rates are altered and global payments are controlled: From gold-based systems to IMF-led coordination, it mirrors a world evolving from a picture of national economies into an interconnected one. The history has been stated below.

Gold Standard (19th Century - 1930s)

• Pre-World War I: The classical gold standard emerged in the 19th century, with many countries tying their currencies to a specific quantity of gold. This system facilitated international trade by providing a stable exchange rate environment.
• Interwar Period: The gold standard faced challenges during and after World War I. Countries suspended the convertibility of their currencies into gold to finance war efforts, leading to disruptions in the international monetary system.

Bretton Woods (1944)

• Formation of Bretton Woods Institutions: In 1944, representatives from 44 Allied nations gathered at the Bretton Woods Conference in New Hampshire, USA. The conference led to the creation of two major institutions: the International Monetary Fund (IMF) and the World Bank.
• Fixed Exchange Rates: The Bretton Woods system established a fixed exchange rate regime, where currencies were pegged to the U.S. dollar, and the U.S. dollar was convertible to gold. This system aimed to provide stability and prevent competitive devaluations.
• Role of the U.S. Dollar: The U.S. dollar became the primary reserve currency, and other currencies were pegged to it. This arrangement, known as the gold exchange standard, provided stability for nearly three decades.

Collapse of Bretton Woods (Early 1970s)

• Nixon Shocks (1971): Facing economic challenges, U.S. President Richard Nixon suspended the convertibility of the U.S. dollar into gold in 1971, known as the "Nixon Shock." This move effectively ended the Bretton Woods system.
• Transition to Floating Exchange Rates: With the collapse of the Bretton Woods system, major currencies transitioned to floating exchange rates, allowing their values to be determined by market forces. This marked a significant shift in the international monetary system.

Floating Exchange Rates (1970s - Present)

• Flexibility and Volatility: The era of floating exchange rates brought greater flexibility but also increased volatility to currency markets. Exchange rates were determined by supply and demand in the foreign exchange markets.
• Regional Monetary Arrangements: Some regions established regional monetary arrangements, such as the European Monetary System (EMS), which preceded the formation of the euro.

Recent Developments (1990s - Present)

• Euro and the Eurozone (1999): The introduction of the euro in 1999 marked a significant step toward economic and monetary integration in the European Union. The euro is the official currency of the Eurozone, a group of countries that share the common currency.
• Financial Crises: The international monetary system has faced challenges, including financial crises in various regions. Institutions like the IMF play a role in providing financial assistance to countries facing economic difficulties.
• Debates on Reform: Ongoing debates and discussions persist about the need for reforms in the international monetary system to address issues such as exchange rate volatility, financial stability, and the role of emerging economies.

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Features of International Monetary System

The IMS is distinguished by a free-floating exchange rate, the reserve assets, and the rules of balance payments adjustment. Stability, liquidity, and confidence contribute towards its three core pillars for collision-free global finance operations. Financial globalization is one of the dominant features of the international monetary system today. The features are stated below.

• Multiple Currencies - The system consists of over 180 national currencies that act as units of account and mediums of exchange for global trade. Each country has its sovereign currency.
• Floating Exchange Rates - Most major currencies have floating exchange rates limited by supply and demand market forces. This feeds flexibility but can lead to volatility.
• Reserve Currencies - A few dominant currencies like the US dollar, euro, Japanese yen, and British pound act as extra currencies for global trade, investments, and central bank reserves.
• Free Capital Flows - There are fairly few rules on the flow of capital among nations. This eases global investment and trade.
• Role of Central Banks - Central banks handle monetary policies and foreign exchange rates within their economies. They aim for price stability, financial health, and balanced payments.
• Functions of IMF - The International Monetary Fund promotes global monetary cooperation, sets standards, and gives financing to member countries in need. It also publishes economic data and research.
• Functions of World Bank - The World Bank gives financing, policy advice, and technical assistance to growing countries for economic action projects.
• Financial Globalization - Growing integration of global financial markets has shaped the modern international monetary system. But it also brings risks of financial contagion.
• Need for Reforms - There are calls to reform the system to address global economic imbalances, financial flux, and lack of replica for emerging economies.

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Functions of International Monetary System

Central banks play a critical role in managing the international monetary system efficiently. It promotes international trade through currency convertibility and management of capital flows. It tries to keep the exchange rates stable and correct the imbalances of international payments.The functions of the international monetary system have been stated below.

• Facilitating Global Trade: The system helps global trade by feeding a set of currencies and exchange rates that act as a joint unit of account. It allows nations to price and settle trade trades.
• Financing Global Trade: The system helps the flow of finance must keep global trade. Importers and exporters can access foreign exchange markets to alter currencies.
• Absorbing Shocks: The system helps absorb economic and financial shocks in one country that could spread to others. The IMF and other institutions feed financing and policy advice to ease contagion risks.
• Boosting Financial Stability: The IMF, along with other actors in the system, work to keep financial stability by watching financial risks, issuing debt, and boosting transparency and alliance.
• Allocating Global Savings: The system gives global savings to where they can be most productively funded. It channels the extra savings of some nations to the deficit nations that need funds.
• Facilitating Diversification of Risk: The system allows nations to diversify macroeconomic risks by allowing global investments and trade in other markets and economies.
• Transmitting Monetary Policies: Shifts in monetary policies and interest rates in one nation can be shared with others through the exchange rate tool in the system.
• Setting Standards and Guidelines: The system - through institutions like the IMF and Bank for International Settlements - sets standards and policies for member nations.

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Importance of International Monetary System

A healthy, nimble, and effective IMS ensures a stable global economy, inspires investments, and prevents financial crisis. It provides the ground level of the confidence required for countries to engage in cross-border trade and the flow of capital. A robust international monetary system enhances transparency and promotes fair economic practices. The essence of the international monetary system has been stated below.

• Facilitates Global Trade and Investment: The most important function of the system is that it enables trade and investment among nations by feeding currencies and exchange rates that act as a joint unit of account. This drives global economic activity.
• Promotes Financial Stability: The system helps boost overall economic stability through institutions like the IMF that scan risks, feed crisis financing, and issue policies. This helps upheld growth.
• Allows Risk Diversification: The system allows nations to diversify their macroeconomic risks by helping global trade and investments across other markets. This makes economies more resilient.
• Transmits Monetary Policies: Shifts in monetary policies and interest rates in one country can be sent to other economies through exchange rate adjustments. This helps blend policies.
• Fosters Economic Growth: An efficient international monetary system easing trade, investment, and risk diversification can support faster economic growth for member nations.
• Reduces Poverty: Economic growth aided by the system can help ease poverty over time by forging more jobs and income options.
• Spreads Technological Inventions: The system boosts the spread of new technologies, management rules, and ideas across borders, also going productivity and growth.
• Sustains Global Economic Stability and Political Stability: A stable and well-functioning international monetary system supports broad geopolitical stability by melding national economies.

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Types of International Monetary System

The types of IMS include: Gold Standard, Bretton Woods System, and Floating Exchange Rate System. The approach taken by each varies regarding the regulation of exchange rates and management of reserves. The types have been explained below.

• Fixed Exchange Rate System: Currencies are pegged to a contract currency (like the US dollar) at a fixed rate. It feeds stability but lacks flexibility. Rarely used in practice now.
• Floating Exchange Rate System: Exchange rates are defined by supply and demand in the foreign exchange market. It feeds more flexibility but can be volatile. Most widely used now.
• Hybrid Exchange Rate System: It blends elements of fixed and floating exchange rates.
• It includes the following.
  • Crawling pegs: Exchange rates adjust in small increments over time.
  • Crawl-like formats: Trade rates shifts within agreed bands.
  • Currency boards: Domestic currency is tied to a foreign currency at a fixed rate.
• Currency Unions: Its member nations adopt a joint currency and share a single monetary policy. Examples include the Eurozone and East Caribbean Currency Union.
• Commodity-based Systems: A commodity (like gold) is used as the top means of payment. Example: The gold standard that was chief earlier.
• Bancor System: It is proposed by Keynes as part of the Bretton Woods system. It involved a global currency (Bancor) backed by a basket of key items. It was not enforced.

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Comparison of Fixed vs Floating Exchange Rate Systems

While fixed exchange rates give protection and predictability, floating rates leave to be flexible and self-correcting. Each has advantages and disadvantages of using them depending on the economy priorities from country to country. The detailed comparison of fixed and floating exchange rates are given below:-

Criteria for Good International Monetary System

A good IMS should feature an effective degree of stability and flexibility, alongside sufficient liquidity supply, and must promote growth while facilitating international trade by providing efficient response channels in the event that the economy encounters global shocks The criteria have been stated below.

• Facilitates Global Trade and Investment: The prior criterion is that the system helps and boosts global trade and financial flows by feeding fair currencies, exchange rates, and financial institutions.
• Boosts Global Economic Stability: The system should be able to absorb economic shocks and upsets in one country without quite moving overall global stability.
• Allows Adjustments for Imbalances: The system must allow for adjustments in exchange rates, trade flows, and capital flows to correct cost inequalities among nations.
• Gives Currency Stability: The system should aim to keep the currencies of member nations rather stable over time to boost trade and investment decisions.
• Accommodates Flexibility: The system must adapt flexibility to adjust to altering economic needs while fostering stability. Both stability and flexibility are vital.
• Encourages Multilateral Coordination: The system works best when fellows cooperate and coordinate economic policies on a multilateral basis via institutions like IMF and regional deals.
• Has Effective Surveillance: The system must have cogent neglect tools to monitor members' economic policies and feed timely alerts of any risks building up.
• Boosts Representation and Participation: The governance of the system should aim for broad phrases and participation of members, mainly arising economies.
• Uses Innovation and Technology: The system must strive to harness creations in technology, finance, and policymaking to further better its functioning over time.

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Evaluation of International Monetary System

Evaluating the IMS would involve an investigation into its potential to promote global monetary cooperation and, thus, stability in the global economy. Public criticism of the current system is often leveled as being mismatched and biased in favor of the dominant currencies of the day, notably the US dollar. Evaluation can be done in the following ways.

• Easing trade and investment - The system has largely been successful in enabling global trade and investment by feeding vital parts like currencies, exchange rates, and financial institutions. Yet, imbalances and volatility pose challenges at times.
• Helping stability - While the system has aided grip economic shocks to an extent, it has also been blamed for failing to prevent global financial crises and flux, as seen in the 1997 Asian financial crisis and the 2007-08 global financial crisis. Reforms are needed to make the system more resilient.
• Helpful flexibility - The move to a more elastic exchange rate system has let economies adjust better to altering conditions. However, undue volatility in currency markets can also be disruptive. A balance of stability and flexibility stays elusive.
• Adjusting imbalances - The system has toiled to enough correct large trade and payments imbalances among nations, which have built up over time. This stresses gaps in surveillance, policy coordination, and incentive tools.
• Representativeness and governance - The system has been criticized for being hogged by a few grown economies and reserve currencies. Growing governance systems to apply rising economies more can enrich legality and efficacy.
• Innovation and reform - The system has evolved over time through next shifts in institutions, rules, and currencies used. However, the pace of reform has often been too slow to keep up with the rapid pace of global economic and financial integration. More dynamic and forward-looking reforms are ought.

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Conclusion

The international monetary system gives the setup for global economic activity by easing global trade, investment, and financial cooperation. While the system has aided notable economic gain, it also faces fusses related to its ability to boost good stability, adjust imbalances, adapt all economies, and enforce timely reforms. On the whole, there seems to be scope for advances to make the system more balanced, agile, and inclusive. While the international monetary system has helped huge global economic growth and integration since World War II, it also faces fusses linked to its ability to boost financial stability, correct imbalances, adjust all economies, and run timely reforms.

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International Monetary System Previous Year UGC NET Question

Which of the following statements is correct regarding the Bretton Woods System?

2008. A) It promoted floating exchange rates among member nations.
      B) The US dollar was pegged to gold, and other currencies were pegged to the US dollar.
      C) It completely abolished the use of gold in global trade.
      D) It was established after the financial crisis of 2008.

Correct Answer: B) The US dollar was pegged to gold, and other currencies were pegged to the US dollar.