Introduction :

The international monetary system refers to the institutional arrangements that countries adopt to govern exchange rates.It encompasses the institutions, instruments, laws, rules, procedures for handling international payments.

International monetary systems are sets of internationally agreed rules, conventions and supporting institutions that facilitate international trade, cross border investment and generally the reallocation of capital between nation states.

It addresses to solve the problems relating to international trade:

                a. Liquidity
b. Adjustment
c. Stability

The problem of Liquidity:
  1. The problem of liquidity existed even in the domestic transactions through barter system.
  2. Barter system was replaced by precious metals as a medium of exchange and store of value.
  3. Gold standard system of international payments came into existence.
The Gold Standard

  1. The first modern international monetary system was the gold standard.
  2. Put in effect in 1850.
  3. Participants – UK, France, Germany & USA.


After World War I, the exchange rates were allowed to fluctuate. Since gold was convertible into currencies of the major developed countries, central banks of different countries either held gold or currencies of these developed countries.

Gold Standard- I ( 1876-1913)

In this system, each currency was linked to a weight of gold. Under gold standard, each country had to establish the rate at which its currency could be converted to a weight of gold E.g. $ 20.67/ ounce  ;  Pound 4.247/ once. Most of the countries used to declare par value of their currency in terms of gold. The problem was every country needed to maintain adequate reserves of gold in order to back its currency.

The Bretton Woods Agreement 

  • Creation of International Monetary Fund (IMF) to promote consultations and collaboration on international monetary problems and countries with deficit balance of payments.
  • Establish a par value of currency with approval of IMF.
  • Maintain exchange rate for its currency within one percent of declared par value.
  • Each member to pay a quota into IMF pool – one quarter in gold and the rest in their own currency.
  • The pool to be used for lending.
  • Dollar was to be convertible to gold till international instrument was introduced.
  • International Bank for Reconstruction and Development (IBRD) was created to rehabilitate war-torn countries and help developing countries.

The System of Bretton Woods ( 1944-71)

  • So in effect this was a gold – dollar exchange standard ( $35/ounce)- known as fixed exchange rate system or adjustable peg.
  • Devaluation could not be resorted arbitrarily.
  • When BOP problem became structural i.e. repetitive, devaluation up to ten percent was permitted by IMF.
  • Thus each currency was tied to dollar directly or indirectly.

Collapse of the Fixed Exchange System

  • The system of fixed exchange rates established at Bretton Woods worked well until the late 1960’s.
  • Any pressure to devalue the dollar would cause problems throughout the world.
  • The trade balance of the USA became highly negative and a very large amount of US dollars  was held outside the USA ; it was more than the total gold holdings of the USA.
  • During end of sixties, European governments wanted gold in return for the dollar reserves they held.
  • On 15th Aug. 1971, President Nixon suspended the system of convertibility of gold and dollar and decided for floating exchange rate system.

The end of the Bretton Woods System (1972–81) 

  • The system dissolved between 1968  and 1973.
  • By March 1973, the major currencies began to float against each other.
IMF members have been free to choose any form of exchange arrangement they wish (except pegging their currency to gold): 
  1. Allowing the currency to float freely.
  2. Pegging it to another currency or a basket of currencies.
  3. Adopting the currency of another country, participating in a currency bloc, or 
  4. Forming part of a monetary union.

Exchange Systems after 1973

Exchange Rate systems are classified on the basis of the flexibility that the monetary authorities show towards fluctuations in the exchange rates and are divided into two categories:
  1. Systems with a fixed exchange rate ( “fixed peg”  or “hard peg”) and
  2. Systems with a flexible exchange rate ( “Floating” systems).
But as usual, between these two extreme positions there exists also an intermediate range of different systems with limited flexibility, usually referred to as “soft pegs”

A fixed peg regime

  1. A fixed peg regime exists when the exchange rate of the home currency is fixed to an anchor currency.
  2. This is the case with economies having currency boards or with no separate national currency of their own. 
  3. Countries do not have a separate national currency, either when they have formally dollarized, or when the country is a member of a currency union, for example Euro.

Floating Exchange Rate System

  • The collapse of Bretton Woods and Smithsonian Agreements coupled with oil crisis of 1970, the floating exchange rate system was adopted by leading industrialised countries.
  • Officially approved in April 1978.
  • Under the system, the exchange rate would be determined by market forces without the intervention of government.
  • No country in the world has adopted freely floating exchange rate system.
  • Floating exchange rate regimes consist of independent floating and managed floating systems.