international monetary system

International monetary system

The global network of government and commercial institutions within which currency exchange rates are determined.

International Monetary System

In foreign exchange, the complete network of governments and institutions that affect currencies. The system has a set of agreed-upon rules that allows for international trade of goods and services. It is important to note that one government's decisions may affect the international monetary system. For example, many countries peg their currencies to the U.S. dollar; when the Federal Reserve makes changes to American monetary policy, it affects those currencies as well. Likewise, import and export laws and decisions on the convertibility of currencies have sometimes significant effects on the international monetary system. See also: Bretton Woods.

Fig. 98 International monetary system. Types of international monetary system.

international monetary system

a system for promoting INTERNATIONAL TRADE and SPECIALIZATION while at the same time ensuring long-run individual BALANCE OF PAYMENTS EQUILIBRIUM. To be effective, an international monetary system must be able to:

1. provide a system of EXCHANGE RATES between national currencies;
2. provide an ADJUSTMENT MECHANISM capable of removing payments imbalance;
3. provide a quantum of INTERNATIONAL RESERVES to finance payments deficits. In addition, because of the structural weaknesses of some countries, particularly DEVELOPING COUNTRIES, financial aid facilitates are required to help resolve problems of indebtedness (see INTERNATIONAL DEBT).

The three functions identified above are highly interrelated, and a crucial role is played by the degree of fixity or flexibility built into the exchange rate mechanism, as Fig. 98 indicates. Thus, if exchange rates are rigidly fixed (see FIXED EXCHANGE RATE SYSTEM), balance of disequilibriums can only be removed by internal price and income adjustments (see BALANCE OF PAYMENTS EQUILIBRIUM), and countries will need to hold large stocks of international reserves to cover deficits while the necessary adjustments are given time to work. By contrast, where exchange rates are free to fluctuate in line with market forces (FLOATING EXCHANGE RATE SYSTEM), continuous external price adjustments will work to remove incipient imbalances before they reach serious proportions, thus reducing countries’ reserve requirements. Various international monetary systems have been tried, including the GOLD STANDARD and, currently, the INTERNATIONAL MONETARY FUND system. See EUROPEAN MONETARY SYSTEM.