Contemporary international monetary system

In the contemporary international monetary system, governments main- tain a variety of exchange-rate arrangements. Some governments allow their currencies to float. Others, such as most governments in the EU, have opted for rigidly fixed exchange rates. Still others, particularly in the developing world, maintain fixed-but-adjustable exchange rates. However, the world’s


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The Economics of the International Monetary System 205

most important currencies—the dollar, the yen, and the euro—are allowed to float against each other, and the monetary authorities in these countries engage only in periodic intervention to influence their values. Consequently, the contemporary international monetary system is most often described as a system of floating exchange rates. We will examine the operation of this system in detail in Chapter 11 .

Is one exchange-rate system inherently better than another? Not nec- essarily. Rather than rank systems as better or worse, it is more useful to recognize that all exchange-rate systems embody an important trade-off between exchange-rate stability on the one hand, and domestic economic autonomy on the other. Fixed exchange rates provide exchange-rate stability, but they also prevent governments from using monetary policy to manage domestic economic activity. Floating exchange rates allow governments to use monetary policy to manage the domestic economy but do not provide much exchange-rate stability. Whether a fixed or a floating exchange rate is better, therefore, depends a lot on the value governments attach to each side of this trade-off. Fixed exchange rates are better for governments that value exchange-rate stability more than domestic autonomy. Floating exchange rates are better for governments that value domestic autonomy more than exchange-rate stability.

The Balance of Payments The balance of payments is an accounting device that records all international transactions between a particular country and the rest of the world for a given period. For instance, any time an American business exports or imports a product, the value of that transaction is recorded in the U.S. balance of pay- ments. Any time an American resident, business, or government loans funds to a foreigner or borrows funds from a foreign financial institution, the value of the transaction is recorded. All of the government’s international transactions also are recorded. When the U.S. government spends money in Iraq support- ing the military, or provides foreign aid to Egypt, these payments are recorded in the balance of payments. By recording all such transactions, the balance of payments provides an aggregate picture of the international transactions the United States conducts in a given year.

Table 10.1 presents the U.S. balance of payments for 2007, the latest year for which complete data are currently available. The transactions are divided into two broad categories: the current account and the capital account. The current account records all current (nonfinancial) transactions between Amer- ican residents and the rest of the world. These current transactions are divided into four subcategories. The trade account registers imports and exports of goods, including manufactured items and agricultural products. The service account registers imports and exports of service-sector activities, such as bank- ing services, insurance, consulting, transportation, tourism, and construction. The income account registers all payments into and out of the United States in connection with royalties, licensing fees, interest payments, and profits.

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