History of Exchange Rate
Regimes
Historical Review
• Over the past 200+ years, the world has gone
though major changes its global exchange
rate environment.
• Starting with the gold standard regime of the
latter part of the 19th century to today’s
somewhat “mixed system” we can identify
there 3 distinct periods:
Gold Standard: 1816 - 1914
 During the 1800s the industrial revolution brought
about a vast increase in the production of goods and
widened the basis of world trade.
 At that time, trading countries believed that a necessary
condition to facilitate world trade was a stable exchange
rate system.


Stable exchange rates were seen as necessary for encouraging
and settling commercial transactions across borders (both by
companies and by governments).
So by the second half of the 19th century, most countries had
adopted the gold standard exchange rate regime.
 Gold Standard: 1870 – 1914
 Bretton Woods System: 1944 – 1973
 Floating Exchange Rate: 1973 -
•
•
Basics of the• Gold
Standard
How it worked:
The gold standard regime required
that domestic currencies (national
money) be defined in terms of a
specific weight of gold.
For example:
–
–
–
–
The British pound was fixed at
.23546% of an ounce of pure gold
(in 1816).
The U.S. dollar was fixed at
0.048379% of an ounce of pure gold
(in 1879).
Thus, the dollar pound “parity” (i.e.,
the exchange rate) was set at $4.867
.23546/.048379 = 4.867
 The Gold Standard also required
that each country adjust its
domestic money supply in direct
relation to the amount of gold it
held.
–
Increase in gold would increase the
domestic money and a reduction in
its gold supply would reduce the
money supply.
•
•
•
•
•
Assume the United Kingdom
ran a trade deficit with the
United States.
As a result, gold would flow
from the UK to the US (gold
financed trade imbalances).
Each country’s domestic money
supply was tied into the amount
of gold it held, thus the U.S.
money supply would rise.
The increase money supply
would increase prices in the
United States, which in turn
would make U.S. goods less
attractive to the UK.
The net result was that the trade
surplus of the US would
decrease and the trade deficit of
the UK would decrease.
World War I (1914) Through
World War II (1944)
 World War I marks the beginning of the end of the Gold Standard .
 During the war, countries suspended the convertibility of their currencies
into gold.
 After WW I, various attempts were made to restore the “classical”
gold standard.


1919: United States returned to a gold standard.
1925: Great Britain joined, followed by France and Switzerland.
 These attempts proved unsuccessful.

Why: During this time, most countries were more concerned with
their national economies than exchange rate stability.

As a result, countries abandoned their attempts to return to an
interwar gold standard.


Bretton Woods: A Pegged Regime
 In July of 1944, as World War II is coming to an end, all 44
allied countries meet in Bretton Woods, New Hampshire for
the purpose of establishing a new international monetary
system.
 At Bretton Woods, countries agree that fixed exchange rates
were necessary for “restarting” world trade and global
investment (both of which had fallen dramatically).
Especially during the Great Depression (1929 – 1930s)
Britain and Japan dropped it in 1931, the U.S. in 1933.
Bretton Woods Agreement
 1. International Monetary Fund (IMF)
Purpose: To lend FX to any member whose supply
of FX had become scarce. (To help the countries
facing difficulty: CA deficit  tight monetary
policy  employment).
Lending would be conditional on the member’s
pursuit of economic policies that IMF would think
appropriate (IMF Conditionality).
Bretton Woods Agreement
 2. The US dollar would be designed as a
reserve currency, and other nations would
maintain their FX reserves in the form of
dollars.
 3. Each country fixed its ex rate against the
dollar and the value of dollar is defined by
the official gold price $35 per ounce (Gold
Exchange Standard).
Bretton Woods Agreement
Bretton Woods System
 4. A Fund member could change its par value
only with Fund approval and only if the
country’s BOP was in “fundamental
disequilibrium”.
 5. Countries would have to make a payment
(subscription) of gold and currency to the
IMF in order to become a member.
 Fixed ex rate system imposes restriction on
monetary policy of countries. Floating ex
rates were regarded as a cause of speculative
instability.
Smithsonian Agreements,
December 1971
 In December 1971, ten major counties meet in Washington,
D.C. with the aim of restoring stability to the international
monetary system.
 Meeting concludes with the Smithsonian Agreements,
whereby:



Key countries agree to revalue their currencies and in essence
set new par values against the US dollar (e.g., yen +17%, mark
+13.5%, pound and franc +9%)
The U.S. also agrees to raise the dollar price of gold from $35
to $38 an ounce (represents a further devaluation of the dollar).
It was also agreed that currencies could now fluctuate +
or – 2.25% around their new par values.
The Final Collapse of the
Dollar, February 1973
 13 months after the Smithsonian Agreements, the dollar comes
under renewed attack for being overvalued.


In February 1973, markets sell off dollars again.
As before, central banks intervene and buy dollars.
 On February, 12th, 1973 the dollar is devalued further to $42
per ounce.




But the price of gold on the London gold markets trades at $70 per
ounce.
Japan and Italy finally let their currencies “float” on February 13th.
France and Germany continue to manage their currencies in relation
to the dollar.
In response to mounting speculative currency flows, foreign
exchange markets are closed on March 1, 1973, and reopen on March
19, 1973.
The End of Bretton Woods
 On March, 19, 1973, when foreign exchange markets
reopen, major countries announce that they are
“floating” their currencies:
 On March 19, 1973, the list of countries floating
their currencies includes Japan, Canada, and those in
Western Europe.
 The Bretton Woods fixed exchange rate system
effectively ends on this date.
 Approximately 3 months later, by June 1973, the dollar
has “floated” down an average of 10% against the
major currencies of the world.
Exchange Rate Regimes Today
 Currently, current exchange rate regimes fall along a
spectrum as represented by national government
involvement in affecting (managing) their currency’s
exchange rate.
Very Little (if any)
Involvement
Active
Involvement
Forex Market is
Determining
Exchange rate
Government is
Managing or
Pegging
Exchange rate
Post Bretton Woods Summary
 Since March 1973, the major currencies of the world have
operated under a floating exchange rate system.

While central banks of these major countries have occasionally
interviewed in support of their currencies, this intervention has become
less over the years.

The US last intervened in 1998.
 In addition to the major currencies of the world, a growing
number of other developing country currencies have also
moved to a floating rate system.



Thus: more and more, market forces are driving currency values.
The post Bretton Woods’ period has resulted exchange rates become
much more volatile and , perhaps, less predictable then they were
during previous fixed exchange rate eras.
This currency volatility complicates the management of global
companies.
Choice of Exchange Rate Regimes
 Fixed or pegged ex rates would work like a gold
standard.
 To keep their prices fixed, countries have to buy or
sell their currencies in FX market (FX market
Intervention).
 Floating (Flexible) ex rates --- the ex rates are
determined by the market forces of demand and
supply.
 No intervention takes place.
A variety of ex rate system
 Managed Floating: MA influences ex rates through
active FX market intervention
 (Independently) Floating: the ex rate is market
determined. No FX intervention.
 Currency Board: A legislative commitment to exchange
A variety of ex rate system
 Fixed Peg: The ex rate is fixed against a major currency.
Active intervention needed.
 Crawling Peg: The ex rate is adjusted periodically in
small amounts at a fixed, preannounced rate.
 Dollarization: The dollar circulates as the legal tender.
domestic currency for a specified foreign currency at a fixed
ex rate.
Choice of Peg or Float
 Peg




Small size (GDP)
Open economy
Harmonious inflation rate
Concentrated trade
 Float




Large size
Closed economy
Divergent inflation rate
Diversified trade
Freely Floating Currencies by
Country or Region, IMF data,
2006
Albania
Congo, Dem. Rep. of
Indonesia
Uganda
Australia
Brazil
Canada
Chile
Iceland
Israel
Korea
Mexico
New Zealand
Norway
Philippines
Poland
South Africa
Sweden
Turkey
United Kingdom
Tanzania
Japan
Somalia
Switzerland
United States
Eurozone
Advantage of Flexible rates
 Each country can produce independent
macroeconomic policies.
 Countries can choose different inflation rates.
Disadvantage of Flexible rates
 The system is subject to destabilizing
speculation



Increase the variability of ex rates
Self-fulfilling prophecy
“evening out” swings in ex rates
Advantage of Fixed rates
 Stable ex rates
 Each country’s inflation rate is “anchored” to
the inflation rate in the US.  price stability
Disadvantage of Fixed rates
 A country cannot follow macroeconomic
policies independent of those of other
countries.
 To maintain the fixed rates, countries need to
share a common inflation experience.
Recall the Definition of an
Exchange Rate Regime
• Defined: The way in which a country manages
its currency and thus the arrangement by the
price of that country’s currency is determined
on foreign exchange markets.
• Arrangements ranging from:
–
–
–
Floating Rate
Managed Rate (AKA “Dirty Float”)
Pegged Rate
• Arrangement is determining by governments.