Future Ims 2011 04 3

Topics: Monetary policy, Currency, Bretton Woods system Pages: 7 (5303 words) Published: November 18, 2014
The Future of the International Monetary System

The Future of the International Monetary
by Ansgar Belke, Kerstin Bernoth and Ferdinand Fichtner

The financial crisis of 2007/2008 and the current “Euro crisis” challenge the current global monetary system. They drastically reveal the actual system’s weaknesses und show the eminent importance of the international monetary system for the stability of markets and national economies. DIW Berlin was commissioned by the Federal Ministry of Finance to research possible alternatives to the existing exchange rate regime. In principle, neither of the two extremes – completely free or fixed exchange rates – is suitable. A mixed system is preferable – with improvements to the status quo, though. An exchange rate regime with few big currency areas, which are linked to each other with flexible exchange rates, should be the aim of reforms. This should correspond to a multi-polar key currency system with the currently dominating US Dollar and the Euro as well as the Chinese Renmimbi as most important actors. These developments should be accompanied by substantial improvements in the regulatory framework of the financial markets. Necessary elements are a reinforced global and especially European economic coordination and an internationally agreed-on, assertive financial market authority.1 1 This report is based on a comprehensive study on the same topic carried out by DIW Berlin on behalf of the Federal Ministry of Finance. See Belke, A., Bernoth, K., Fichtner, F. (2011): Die Zukunft des internationalen Währungssystems. DIW Berlin: Politikberatung kompakt (currently being published).

Over the past 150 years, the global monetary system has
seen a number of varying degrees of links between different currencies (Box 1). Periods of very strong ties between the main currencies of the global economy (like during the gold standard or the Bretton Woods system)

alternated (at least shortly) with regimes of relatively
high flexibility of exchange rates (mostly after the breakdown of relatively narrow regimes), e.g. after the end of the gold standard in the 1920s and when the intra-European exchange rates became much more f lexible following the collapse of the European currency system at the beginning of the 1990s. From a global perspective, there has been a tendency towards more flexible exchange rates in the past years.2

Advantages and Disadvantages of Flexible
and Fixed Exchange Rates
The global economic and financial crisis has caused
doubts about the existing global exchange rate system.
Strong fluctuations in exchange rates, be it between the
US Dollar and the Euro or Eastern European currencies,
regularly lead to financial market uncertainties, while at
the same time fixed exchange rates like between China
and the USA support the build-up of massive imbalances. In principle, two extreme forms of exchange rate regimes can be imagined: Full f lexibility and a complete fixing of global exchange rates. Full f lexibility would hold the advantage of combating global imbalances and

the spill-over of economic ups and downs. With f lexible exchange rates, a country’s current account surplus leads to the appreciation of the local currency because
of higher demand for the domestic currency. This makes exports more expensive on the global market, whereas prices for imports go down from the country’s own perspective. As a consequence, the foreign trade surplus

diminishes. An excessive, permanent export surplus of

2 The establishment of the European Monetary Union obviously works against this trend.

DIW Economic Bulletin 4.2011


The Future of the International Monetary System

the type we observe in case of the Chinese economy is
less probable in a system of flexible exchange rates.
In many other emerging countries, this connection
works the other way around: Based on their high economic growth, domestic demand and imports as well as domestic...
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