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International Finance Spring 2023

Assignment 1
Zelalem Degene

Assess the possibility for the Euro to become another global currency rivaling the US
dollar. If the Euro really becomes the global currency, what impact will it have on the US
dollar and the world economy?
The Euro has a chance to overtake the US dollar and maintain its position as the dominant
international reserve currency, but the issue is that the EA's banking system is still very scattered,
making it more difficult to capitalize on economies of scale, scope, and network externalities.
Additionally, because the EU and the EA are only unions of independent nations and not federal
states, it will be extremely challenging to do so while their respective state institutions are still in
place.

For the single-currency euro to come near matching the US Dollar as a reserve currency, the
world will have to be convinced of the durability and success of the single economy it is based
on. Ultimately, the fate of the Euro will mirror the fate of the European economy. Based on the
economic fundamentals, the euro certainly has the potential to become a second reserve currency
for the world’s financial system. Together, the eleven economies of the EMU are almost as large
as the United States. In some key indicators of international strength, the euro nations already are
stronger. Collectively, they now enjoy a trade and current account surplus and are net creditors to
the rest of the world. The single currency's scale and the euro zone's size also bring new
opportunities to the global economy. It makes the Eurozone a more attractive region for non-EU
countries to do business with, thus promoting trade and investment. Although all EU Member
States are part of the Economic and Monetary Union, not all EU countries are part of the euro
area, which includes only those that have adopted the euro as their currency and are subject to
the monetary policy of the European Central Bank.

Once capital markets are integrated; it is difficult for a country to maintain a fixed
exchange rate? Explain why this may be so.
Once the capital markets are interconnected, it becomes challenging for a nation to keep its
currency constant since enormous sums of money may enter and leave the nation quickly. As a
result, the country will find it exceedingly challenging to keep a constant exchange rate.

Discuss the criteria for a “good” international monetary system.

A "good" international monetary system must be able to support the global economy with
adequate liquidity and make quick adjustments to any imbalances in the balance of payments that
may occur. The currency has to be agreed to have a certain value without inhibiting the economy
of the country. This is essential in that if you don't have it, one of the countries that fall out will
feel economic pressure that could topple the economy and send it in a downward spiral while
benefiting other countries. This will eventually result the inflation or deflation of the value of the
international currency which could lead to its downfall.
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International Finance Spring 2023
Assignment 1
Zelalem Degene

Explain the arrangements and workings of the European Monetary System (EMS)

The main goals of the European Monetary System are to control inflation and reduce significant
exchange rate swings among European nations. The Currency fluctuations were controlled
through an exchange rate mechanism also called ERM.

This System is based on the parity grid system that underpins the ERM and is constructed by
first determining the par values of the EMS currencies in terms of the ECU. A nation's policies
must be adjusted if the market exchange rate for its ECUs deviates from the central rate by more
than the maximum permitted deviation in order to preserve its par value in relation to other
currencies.

What were the main objectives of the Bretton Woods System?

The first goal was to create a monetary system more flexible than the gold standard. The gold
standard makes it difficult or impossible for governments to adjust the value of their currency based
on their country’s economic needs and forces central banks to hold vast reserves of the metal.

The second goal was to prevent governments from devaluing their currencies to compete with other
countries in the import and export markets. The new system aimed to establish fixed exchange
rates between the monies involved.

Third, the agreement sought to encourage economic growth among the member nations through a
combination of stabilizing currency values, fostering international trade, and establishing bodies like
the World Bank and the International Monetary Fund to help countries grow their economies.

Reference

- Rey, J. J. (1980). European Monetary System, The. Common Market L. Rev., 17, 7.

- Fratianni, M., & Von Hagen, J. (2019). The European monetary system and European
monetary union. Routledge
- Williams, J. H. (1945). The Bretton Woods Agreements. Proceedings of the Academy of
Political Science, 21(3), 40–50. https://doi.org/10.2307/1173058