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International Economics II-1
International Economics II-1
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International Economics II (3082)
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The foreign exchange market can be used as a basis for comparative statics exercises. We can study how changes
in an economy affect the exchange rate. For example, suppose there is an increase in the level of economic activity in the
United States. This will lead to an increase in the demand for European goods and services. To make these purchases, US
households and firms will demand more euros. This will cause an outward shift in the demand curve and an increase in
the dollar price of euros. When the dollar price of a euro increases, we say that the dollar has depreciated relative to the
euro. From the perspective of the euro, the depreciation of the dollar represents an appreciation of the euro.
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rising currency value while a country with higher inflation typically sees depreciation in its currency and is
usually accompanied by higher interest rates
Interest Rates: Changes in interest rate affect currency value and dollar exchange rate. Forex rates, interest rates,
and inflation are all correlated. Increases in interest rates cause a country's currency to appreciate because higher
interest rates provide higher rates to lenders, thereby attracting more foreign capital, which causes a rise in
exchange rates.
Country's Current Account / Balance of Payments: A country's current account reflects balance of trade and
earnings on foreign investment. It consists of total number of transactions including its exports, imports, debt, etc.
A deficit in current account due to spending more of its currency on importing products than it is earning through
sale of exports causes depreciation. Balance of payments fluctuates exchange rate of its domestic currency.
Government Debt: Government debt is public debt or national debt owned by the central government. A country
with government debt is less likely to acquire foreign capital, leading to inflation. Foreign investors will sell their
bonds in the open market if the market predicts government debt within a certain country. As a result, a decrease
in the value of its exchange rate will follow.
Terms of Trade: A trade deficit also can cause exchange rates to change. Related to current accounts and
balance of payments, the terms of trade are the ratio of export prices to import prices. A country's terms of trade
improve if its exports prices rise at a greater rate than its imports prices. This results in higher revenue, which
causes a higher demand for the country's currency and an increase in its currency's value. This results in an
appreciation of exchange rate.
Political Stability & Performance: A country's political state and economic performance can affect its currency
strength. A country with less risk for political turmoil is more attractive to foreign investors, as a result, drawing
investment away from other countries with more political and economic stability. Increase in foreign capital, in
turn, leads to an appreciation in the value of its domestic currency. A country with sound financial and trade
policy does not give any room for uncertainty in value of its currency. But, a country prone to political confusions
may see a depreciation in exchange rates.
Recession: When a country experiences a recession, its interest rates are likely to fall, decreasing its chances to
acquire foreign capital. As a result, its currency weakens in comparison to that of other countries, therefore
lowering the exchange rate.
Speculation: If a country's currency value is expected to rise, investors will demand more of that currency in
order to make a profit in the near future. As a result, the value of the currency will rise due to the increase in
demand. With this increase in currency value comes a rise in the exchange rate as well.
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Speculation is the purchase or sale of an asset in the expectation of a gain from changes in the price of that asset.
For speculators as a group actually to earn a profit requires that merchants be willing to sell for future delivery at prices
lower than those they expect in the future. One reason why they might do so is that by hedging, they eliminate risk; and
the difference between the price at which they sell and the price they expect in the future is the risk premium—somewhat
analogous to the premium one pays for insurance (over and above the actuarial value of the risk).
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Money as a Standard of Deferred Payment: The above function is somehow related to the first, as it creates
credit and allows transactions to be settled in the future. To be a standard of deferred payment, money must be an
accepted way to value and settle a debt in the future.
Money as a Store of Wealth: As services can’t be stored and a lot of goods are perishable, society requires more
effective ways of storing wealth. Money can be easily stored, retrieved, and used at a later time, and, at least in
times of low inflation, it’s able to maintain most of its value.
Money as a Measure of Value: Money can be used as a universal unit of account to measure the value of all the
goods and services exchanged in an economy. In a money-based economy, prices can be indicated using only one
measure of value, simplifying transactions and people’s understanding of how much a good or service is worth.
Conversely, in a barter economy, the prices for a good or service should be established based on all the other
goods or services produced and exchanged.
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policy of credit squeeze by raising the bank rate and purchasing securi ties through open market operations and adopting
other credit control measures.
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o Unilateral Transfers sent abroad: Foreign exchange is required for making unilateral transfers like sending
gifts to other countries.
o Purchase of Assets in Foreign Countries: It is demanded to make payment for purchase of assets, like land,
shares, bonds, etc. in the foreign countries.
o Speculation: Demand for foreign exchange arises when people want to make gains -from appreciation of
currency.
The demand for foreign currency rises in the following situations:
o When price of a foreign currency falls, imports from that foreign country become cheaper. So, imports increase
and hence, the demand for foreign currency rises. For example, if price of 1 US dollar falls from Rs 50 to Rs 45,
then imports from USA will increase as American goods will become relatively cheaper. It will raise the demand
for US dollars.
o When a foreign currency becomes cheaper in terms of the domestic currency, it promotes tourism to that country.
As a result, demand for foreign currency rises.
o When price of a foreign currency falls, its demand rises as more people want to make gains from speculative
activities.
Demand curve of foreign exchange slope downwards due to inverse relationship between demand for foreign
exchange and foreign exchange rate.
In Fig. 11.1, demand for foreign exchange (US dollar) and rate of foreign exchange are shown on the X- axis and
Y-axis respectively. The negatively sloped demand curve (DD) shows that more foreign exchange (OQ 1) is demanded at a
low rate of exchange (OR1), whereas, demand for US dollars falls to OQ 2 when the exchange rate rises to OR2.
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debits. In other words, with regard to assets, whether real or financial, decreases in holdings are recorded as credits, while
increases in holdings are recorded as debits. On the other hand, increases in liabilities are recorded as credits, while
decreases in liabilities are recorded as debits. In practice, the figures rarely balance to the point where they cancel each
other out. This is the result of errors or missions in the compilation of statements. A separate balancing item is used to
offset the credit or debit.
However, there is no book-keeping requirement that the sums of the two sides of a selected number of balance of
payments accounts should be the same, and it happens that the balances shown by certain combinations of accounts are of
considerable interest to analysts and government officials. It is these balances that are often referred to as “surpluses” or
“deficits” in the balance of payments. The following some simple rules of thumb help to the reader to understand the
application of accounting principles for balance of payments accounting.
Any individual or corporate transaction that leads to increase in demand for foreign currency (exchange) is to be
recorded as debit, because if is cash outflow, while a transaction which results in increase the supply of foreign currency
(exchange) is to be recorded as a credit entry. All transactions, which result an immediate or prospective payment from
the rest of the world to the country should be recorded as credit entry. On the other hand, the transactions, which result in
an actual or prospective payment from the country to the rest of the world should be recorded as debits.
Credit Debit
1. Exports of goods and services 1. Imports of goods and services
2. Income receivable from abroad 2. Income payable to abroad
3. Transfers from abroad 3. Transfers to abroad
4. Increases in external liabilities 4. Decreases in external liabilities
5. Decreases in external assets 5. Increases in external assets
Thus balance of payments credits denote a reduction in foreign assets or an increase in foreign liabilities, while
debits denote an increase in foreign assets or a reduction of foreign liabilities. In balance of payments accounting the
principle of accrual accounting governs the time of recording of transactions. Therefore, transactions are recorded when
economic value is created, transformed, exchanged, transferred, or extinguished. Claims and liabilities arise when there is
a change in ownership. Put in simple words, balance of payments is usually prepared for a year but may be divided into
quarters as well.
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All capital transactions between the countries are monitored through the capital account. Capital transactions
include purchasing and selling assets (non-financial) like land and properties. The capital account also includes the flow
of taxes, purchase and sale of fixed assets etc., by migrants moving out/into a different country. The deficit or surplus in
the current account is managed through the finance from the capital account and vice versa. There are three major
elements of a capital account:
Loans and borrowings – It includes all types of loans from the private and public sectors located in foreign
countries.
Investments – These are funds invested in corporate stocks by non-residents.
Foreign exchange reserves – Foreign exchange reserves held by the country’s central bank to monitor and
control the exchange rate do impact the capital account.
o Financial Account
The flow of funds from and to foreign countries through various investments in real estate, business ventures,
foreign direct investments etc., is monitored through the financial account. This account measures the changes in the
foreign ownership of domestic assets and domestic ownership of foreign assets. Analysing these changes can be
understood if the country is selling or acquiring more assets (like gold, stocks, equity, etc.).
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Errors and Omissions: If in case the receipts and payments do not match with each other than balance amount
will be shown as errors and omissions.
Comparison Chart
BASIS FOR BALANCE OF TRADE BALANCE OF PAYMENT
COMPARISON
Meaning Balance of Trade is a statement that Balance of Payment is a statement that keeps
captures the country's export and track of all economic transactions done by the
import of goods with the remaining country with the remaining world.
world.
Records Transactions related to goods only. Transactions related to both goods and services
are recorded.
Capital Transfers Are not included in the Balance of Are included in Balance of Payment.
Trade
Which is better? It gives a partial view of the It gives a clear view of the economic position of
country's economic status. the country.
Result It can be Favourable, Unfavourable Both the receipts and payment sides tallies.
or balanced.
Components It is a component of Current Current Account and Capital Account.
Account of Balance of Payment.
The following are the major differences between the balance of trade and balance of payments:
A statement recording the imports and exports done in goods by/from the country with the other countries, during
a particular period is known as the Balance of Trade. The Balance of Payment captures all the monetary
transaction performed internationally by the country during a course of time.
The Balance of Trade accounts for, only physical items, whereas Balance of Payment keeps track of physical as
well as non-physical items.
The Balance of Payments records capital receipts or payments, but Balance of Trade does not include it.
The Balance of Trade can show a surplus, deficit or it can be balanced too. On the other hand, Balance of
Payments is always balanced.
The Balance of Trade is a major segment of Balance of Payment.
The Balance of Trade provides the only half picture of the country’s economic position. Conversely, Balance of
Payment gives a complete view of the country’s economic position.
Every country of the world keeps the record of inflow and outflow of money in the economy with the help of a
Balance of Trade and Balance of Payments. They reflect the actual position of the whole economy. With the help of BOT
and BOP, analysis and comparisons can also be made that how much trade has increased or decreased, since the last
period.
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o The decrease or increase in official reserves is known as the overall balance of payments deficit or surplus.
o The fundamental hypothesis is that the monetary authorities are the final financiers of any deficit in the BoP(or
the recipients of any surplus.
o Official reserve transactions are relevant under the reign of the fixed exchange rates than when exchange rates are
floating.
o There are many factors that may lead to a BOP deficit or surplus:
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relation to other countries, both exports and imports may increase. But there can be either a surplus or deficit in
BOP situation depending upon whether the country exports more than imports or imports more than exports. In
both the cases, there will be disequilibrium in BOP.
Changes in National Income: Another cause is the change in the country’s national income. If the national
income of a country increases, it will lead to an increase in imports thereby creating a deficit in its balance of
payments, other things remaining the same. If the country is already at full employment level, an increase in
income will lead to inflationary rise in prices which may increase its imports and thus bring disequilibrium in the
balance of payments.
Price Changes: Inflation or deflation is another cause of disequilibrium in the balance of payments. If there is
inflation in the country, prices of exports increase. As a result, exports fall. At the same time, the demand for
imports increase. Thus increase in export prices leading to decline in exports and rise in imports results in adverse
balance of payments.
Stage of Economic Development: A country’s balance of payments also depends on its stage of economic
development. If a country is developing it will have a deficit in its balance of payments because it imports raw
materials, machinery, capital equipment, and services associated with the development process and exports
primary products. The country has to pay more for costly imports and gets less for its cheap exports. This leads to
disequilibrium in its balance of payments.
Capital Movements: Borrowings and lending’s or movements of capital by countries also result in
disequilibrium in BOP. A country which gives loans and grants on a large scale to other countries has a deficit in
its BOP on capital account. If it is also importing more, as is the case with the USA, it will have chronic deficit.
On the other hand, a developing country borrowing large funds from other countries and international institutions
may have a favourable BOP. But such a possibility is remote because these countries usually import huge
quantity of food, raw materials, capital goods, etc. and export primary products. Such borrowings simply help in
reducing BOP deficit.
Political Conditions: Political condition of a country is another cause of disequilibrium in BOP. Political
instability in a country creates uncertainty among foreign investors which leads to the outflow of capital and
retards its inflow. This causes disequilibrium in BOP of the country. Disequilibrium in BOP also occurs in the
event of war or fear of war with some other country.
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autonomous payments.
[Current A/c + Capital A/c Receipts] > [Current A/c + Capital A/c Payments]
Autonomous transactions are those transactions which are carried out with economic
motive irrespective of the present position of the Balance of Payment.
This situation arises only on account of autonomous transactions.
Correction of BOP surplus To remove the surplus government will:
Deposit the excess foreign exchange in its Foreign Exchange Reserves.
This is an accommodating transaction of the government made only to bring
equilibrium in the Balance of Payment.
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equilibrium.” This is automatically achieved by depreciation of a country’s currency in case of deficit in its balance of
payments. Depreciation of a currency means that its relative value decreases. Depreciation has the effect of encouraging
exports and discouraging imports.
When exchange depreciation takes place, foreign prices are translated into domestic prices. Suppose the dollar
depreciates in relation to the pound. It means, that the price of dollar falls in relation to the pound in the foreign exchange
market. This leads to the lowering of the prices of U.S. exports in Britain and raising of the prices of British imports in the
U.S. When import prices are higher in the U.S., the Americans will purchase less goods from the Britishers. On the other
hand, lower prices of U.S. exports will increase exports and diminish imports, thereby bringing equilibrium in the balance
of payments.
o Devaluation or Expenditure-Switching Policy:
Devaluation raises the domestic price of imports and reduces the foreign price of exports of a country devaluing
its currency in relation to the currency of another country. Devaluation is referred to as expenditure switching policy
because it switches expenditure from imported to domestic goods and services. When a country devalues its currency, the
price of foreign currency increases which makes imports dearer and exports cheaper. This causes expenditures to be
switched from foreign to domestic goods as the country’s exports rise and the country produces more to meet the
domestic and foreign demand for goods with reduction in imports. Consequently, the balance of payments deficit is
eliminated.
o Direct Controls:
To correct disequilibrium in the balance of payments, government also adopts direct controls which aim at
limiting the volume of imports. The government restricts the import of undesirable or unimportant items by levying heavy
import duties, fixation of quotas, etc. At the same time, it may allow imports of essential goods duty free or at lower
import duties, or fix liberal import quotas for them. For instance, the government may allow free entry of capital goods,
but impose heavy import duties on luxuries. Import quotas are also fixed and the importers are required to take licenses
from the authorities in order to import certain essential commodities in fixed quantities.
In these ways, imports are reduced in order to correct an adverse balance of payments. The government also
imposes exchange controls. Exchange controls have a dual purpose. They restrict imports and also control and regulate
the foreign exchange. With reduction in imports and control of foreign exchange, visible and invisible imports are
reduced. Consequently, an adverse balance of payment is corrected.
o Adjustment through Capital Movements:
A country can use capital imports to correct a deficit in its balance of payments. A deficit can be financed by
capital inflows. When capital is perfectly mobile within countries, a small rise in the domestic rate of interest brings a
large inflow of capital. The balance of payments is said to be in equilibrium when the domestic interest rate equals the
world rate. If the domestic interest rate is higher than the world rate, there will be capital inflows and the balance of
payments deficit is corrected.
o Adjustment through Income Changes:
Given the foreign exchange rate and prices in a country, an increase in the value of exports, causes an increase in
the incomes of all persons associated with the export industries. These, in turn, create demand for other goods and
services within the country. This will raise the incomes of persons engaged in the latter industries and services. This
process will continue and the national income increases by the value of the multiplier.
o Stimulation of Exports and Import Substitutes:
A deficit in the balance of payments can also be corrected by encouraging exports. Exports can be encouraged by
producing quality products, by increasing exports through increased production and productivity, and by better marketing.
They can also be increased by a policy of import substitution. It means that the country produces those goods which it
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imports. In the beginning imports are reduced but in the long run exports of such goods start. An increase in exports cause
the national income to rise by many times through the operation of the foreign trade multiplier. The foreign trade
multiplier expresses the change in income caused by a change in exports. Ultimately, the deficit in the balance of
payments is removed when exports rise faster than imports.
o Expenditure-Reducing Policies:
A deficit in the balance of payments implies an excess of expenditure over income. To correct it, expenditure and
income should be brought into equality. For this expenditure reducing monetary and fiscal policies are used. A
contractionary or tight monetary policy relates to increase in interest rates to reduce money supply and a contractionary
fiscal policy relates to reduction in government expenditure and or increase in taxes. Thus expenditure reducing policies
reduce aggregate demand through higher taxes and interest rates, thereby reducing expenditure and output. The reduction
in expenditure and output, in turn, reduces the domestic price level. This gives rise to switching of expenditure from
foreign to domestic goods. Consequently, the country’s imports are reduced and the balance of payments deficit is
corrected.
But the extent to which it will succeed depends on the country’s price elasticities of domestic demand for imports and
foreign demand for exports. This is what the Marshall -Lerner condition states: when the sum of price elasticities of
demand for exports and imports in absolute terms is greater than unity, devaluation will improve the country’s balance of
payments, i.e. ex + em > 1
Where ex is the demand elasticity of exports and Em is the demand elasticity for imports. On the contrary, if the
sum of price elasticities of demand for exports and imports in absolute terms, is less unity, e x + em > 1, devaluation will
worsen (increase the deficit) the BOP. If the sum of these elasticities in absolute terms is equal to unity, e x + em = 1,
devaluation has no effect on the BOP situation which will remain unchanged.
The following is the process through which the Marshall-Lerner condition operates in removing BOP deficit of a
devaluing country. Devaluation reduces the domestic prices of exports in terms of the foreign currency. With low prices,
exports increase. The extent to which they increase depends on the demand elasticity for exports. It also depends on the
nature of goods exported and the market conditions. If the country is the sole supplier and exports raw materials or
perishable goods, the demand elasticity for its exports will be low. If it exports machinery, tools and industrial products in
competition with other countries, the elasticity of demand for its products will be high, and devaluation will be successful
in correcting a deficit.
Devaluation has also the effect of increasing the domestic price of imports which will reduce the import of goods.
By how much the volume of imports will decline depends on the demand elasticity of imports. The demand elasticity of
imports, in turn, depends on the nature of goods imported by the devaluing country. If it imports consumer goods, raw
materials and inputs for industries, its elasticity of demand for imports will be low. It is only when the import elasticity of
demand for products is high that devaluation will help in correcting a deficit in the balance of payments. Thus it is only
when the sum of the elasticity of demand for exports and the elasticity of demand for imports is greater than one that
devaluation will improve the balance of payments of a country devaluing its currency.
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The money supply (Ms) is a multiple of monetary base (m) which consists of domestic money (credit) (D) and
country’s foreign exchange reserves (R). Ignoring m for simplicity which is a constant,
MS = D + R ……………… (2)
Since in equilibrium the demand for money equals the money supply,
MD = Ms .. (3)
or MD = D + R [MS = D + R] …………(4)
A balance of payments deficit or surplus is represented by changes in the country’s foreign exchange reserves. Thus
∆R = ∆MD – ∆D ………………….. (5)
Or ∆R = B … ( 6)
Where B represents balance of payments which is equal to the difference between change in the demand for
money (∆MD) and change in domestic credit (∆D). A balance of payments deficit means a negative B which reduces R
and the money supply. On the other hand, a surplus means a positive B which increases R and the money supply. When B
= O, it means bop equilibrium or no disequilibrium of BOP. The automatic adjustment mechanism in the monetary
approaches is explained under both the fixed and flexible exchange rate systems.
Stabilization Policies
Fiscal Policy
Fiscal policy refers to the use of government spending and tax policies to influence economic conditions,
especially macroeconomic conditions. These include aggregate demand for goods and services, employment, inflation,
and economic growth. During a recession, the government may lower tax rates or increase spending to encourage demand
and spur economic activity. Conversely, to combat inflation, it may raise rates or cut spending to cool down the economy.
Fiscal policy is often contrasted with monetary policy, which is enacted by central bankers and not elected government
officials.
U.S. fiscal policy is largely based on the ideas of British economist John Maynard Keynes (1883-1946). He
argued that economic recessions are due to a deficiency in the consumer spending and business investment components of
aggregate demand. Keynes believed that governments could stabilize the business cycle and regulate economic output by
adjusting spending and tax policies to make up for the shortfalls of the private sector. His theories were developed in
response to the Great Depression, which defied classical economics' assumptions that economic swings were self-
correcting. Keynes' ideas were highly influential and led to the New Deal in the U.S., which involved massive spending
on public works projects and social welfare programs.
Tools of Fiscal Policy
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A government has two tools at its disposal under the fiscal policy – taxation and public spending. Taxation
includes taxes on income, property, sales, and investments. On the one hand, more taxes mean more income for the
government, but it also results in less income in the hand of the people. Public spending includes subsidies, and transfer
payments, like salaries to government employees, welfare programs, and public works projects. Those who get the funds
have more money to spend.
Types of Fiscal Policy: There are two types of fiscal policy – expansionary and contractionary fiscal policy.
o Expansionary Fiscal Policy: A government uses this type of policy to stimulate economic growth by increasing
spending or lowering taxes, or both. The objective of this policy is to ensure more money in the hands of the
citizens so that they spend more. More spending, in turn, leads to more income and more job creation. There have
been debates over which is more effective – tax cuts or spending. Some say that spending in the form of public
projects ensures that the money reaches the consumers. Those in favour of the tax argue that tax cuts allow
businesses to hire more staff. Though there is no consensus on which of the two is better, the government uses a
combination of both tools to boost economic growth.
o Contractionary Fiscal Policy: A government rarely uses this policy as it aims to slow economic growth. You
must be thinking about why any government will want to do that. The answer is to curtail inflation. Too much
inflation has the potential to damage the economy in the long term. So, the government has to step in to control
inflation. Here also, the government has the same tools at its disposal – spending and tax cuts. But, they are used
differently – taxes are raised while the spending is reduced. One can easily imagine how unpopular such
measures will be among the voters.
o A Balanced Approach: A government always faces a risk that more spending and lower tax rates could fuel
inflation. This happens because more money in the economy pushes the consumer demand up, eventually leading
to a fall in the value of money. This means it now takes more money to buy a product or service whose value is
not changed. So, it is very important for a government to monitor its fiscal policy constantly. And, if there are any
signs of inflation going out of control, the government must address it accordingly.
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reserves of the country, and so those countries have to give up on Classic Gold Standard. The only United States of
America didn’t give up on Classic Gold Standards.
o Interwar Period
The period between World War 1 and World War 2 is known as the Interwar Period. This was the next episode of
the International Monetary System from 1915 to 1944. During this time, Britain was replaced by the United States of
America as the dominant financial powerhouse across the globe. During this period, all the economies had gone into a
depression with a higher inflation rate. The fixed exchange rate system collapsed with a higher supply of money. Almost
all countries started focussing on domestic revamping and not on international trade.
o Bretton Woods System
The period after World War 2 gave birth to Bretton Woods System. This monetary system was in existence from
1945 to 1972. Representatives from 44 countries, in the year 1944, met at Bretton Woods of the United States and came
up with a new International Monetary System. The focus of the Bretton Woods Agreement was to establish a uniform and
liberal International Financial Architecture with independence on domestic policies. This agreement gave birth to the US
Dollar-based Monetary System or Gold-Exchange Standard. This system gave birth to the pegging of domestic currency
in terms of US Dollars. A price of $35 was set for 1 ounce of gold—the countries, rather than linking their currency to the
gold-linked it to US Dollars.
All the member countries of Bretton Woods had to maintain their currencies value within 1% upward or
downward variations in comparison to Fixed Exchange Rate. This agreement also allowed the Governments of the
country to convert their gold into the US Dollar at any point in time. Eventually, countries and businesses have started
ignoring the link between US Dollar and Gold and have started considering exchange rates directly. If the situation
prevailed, then Bretton Woods Agreement allowed the country to devalue its currency by more than 10% straight.
Although, it didn’t allow countries to use this mechanism to benefit from imports and exports of the country.
Post-World War situation, the supply of US Dollars suddenly increased in the world economy. As a result of it,
many countries started questioning the quantum of gold reserves of the US Government with the supply of the US Dollar.
By 1973, many countries started losing confidence in the US Dollar and started searching for some other reliable sources.
o Current International Monetary System
After the downfall of the Bretton Woods System, there has not been any formal International Monetary System in
place. The present-day International Financial Architecture is a managed float system. All the currencies of all the
countries can freely float against one another in an open market under the managed float system. The government
intervenes only when the currency needs to be stabilized. Managed Float System has been in place since 1976 with the
Jamaica Agreement. Later in 1980, the International Financial Architecture was regulated by G-5 countries. This G-5
group has currently turned into G-20, with a group of 20 countries managing the exchange rate on managed float system.
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IMF grants are given to charities in Washington D.C. and member countries. The grants are meant to foster
economic independence through education and economic development." The average grant size is $15,000
o What Is the Difference Between the International Monetary Fund and the World Bank?
The International Monetary Fund is primarily focused on the stability of the global monetary system and
monitoring the currencies of the world. The aim of the World Bank is to reduce poverty across the world and strengthen
the low- to middle-class populations.
o The Bottom Line
The IMF works to help reduce poverty, encourage trade, and promote financial stability and economic growth
around the world. It accomplishes this by monitoring capacity building and providing loans. While the IMF is currently
working on these goals with its 190 member nations, the organization has still faced criticism for the possible negative
impacts of its structural adjustment programs.
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arm—the International Bank for Reconstruction and Development (IBRD). IDA supports a range of development
activities that pave the way toward equality, economic growth, job creation, higher incomes, and better living
conditions. IDA is one of the largest sources of assistance for the world’s 74 poorest countries and is the single
largest source of donor funds for basic social services in these countries. IDA lends money on concessional terms.
This means that IDA credits have a zero or very low interest charge and repayments are stretched over 30 to 40
years. More than half of IDA countries receive all, or half, of their IDA resources on grant terms, which carry no
repayments at all. These grants are targeted to the low-income countries at higher risk of debt distress.
International Finance Corporation (IFC): It provides financing of private-enterprise investment in developing
countries around the world, through both loans and direct investments. Affiliated with the World Bank, it also
provides advisory services to encourage the development of private enterprise in nations that might be lacking the
necessary infrastructure or liquidity for businesses to secure financing. The IFC was established in 1956 as a
member of the World Bank Group, focused on investing in economic development. It claims to be the largest
global development institution focused on the private sector in developing countries. The IFC says it also seeks to
ensure that private enterprises in developing nations have access to markets and financing. The IFC's most recent
stated goals include the development of sustainable agriculture, expanding small businesses' access to
microfinance, supporting infrastructure improvements, as well as promoting climate, health, and education
policies. The IFC is governed by its 184 member countries and is headquartered in Washington, D.C.
Multilateral Investment Guarantee Agency (MIGA): It is an international institution that promotes investment
in developing countries by offering political and economic risk insurance. By promoting foreign direct
investment into developing countries, the agency aims to support economic growth, reduce poverty, and improve
people’s lives. The Multilateral Investment Guarantee Agency (MIGA) is a member of the World Bank Group
and is headquartered in Washington, D.C. As of March 2020, 181 member governments make up MIGA—156
developing nations and another 25 industrialized countries. The agency was created to complement both public
and private investment insurance sources against non-commercial risks in developing countries. Its multilateral
character and sponsorship by advanced and developing nations were seen as bolstering confidence among people
going across borders to invest their money. In September 1985, the World Bank endorsed the idea of a
multilateral political risk insurance provider and established MIGA in April 1988. The agency started out with $1
billion worth of capital among its initial 29 member states.
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Department of Economics, Gambella University, Ethiopia
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services trade claims that give rise to them. Thus, a country with a current account deficit necessarily has a capital
account surplus.
Multinational Corporations
A multinational corporation (MNC) is a company that operates in its home country, as well as in other countries
around the world. It maintains a central office located in one country, which coordinates the management of all its other
offices, such as administrative branches or factories.
The following are the different models of multinational corporations:
Centralized: In the centralized model, companies put up an executive headquarters in their home country and
then build various manufacturing plants and production facilities in other countries. Its most important advantage
is being able to avoid tariffs and import quotas and take advantage of lower production costs.
Regional: The regionalized model states that a company keeps its headquarters in one country that supervises a
collection of offices that are located in other countries. Unlike the centralized model, the regionalized model
includes subsidiaries and affiliates that all report to the headquarters.
Multinational: In the multinational model, a parent company operates in the home country and puts up
subsidiaries in different countries. The difference is that the subsidiaries and affiliates are more independent in
their operations.
The following are the common characteristics of multinational corporations:
The following are the common characteristics of multinational corporations:
Very high assets and turnover: To become a multinational corporation, the business must be large and must
own a huge amount of assets, both physical and financial. The company’s targets are high, and they are able to
generate substantial profits.
Network of branches: Multinational companies maintain production and marketing operations in different
countries. In each country, the business may oversee multiple offices that function through several branches and
subsidiaries.
Control: In relation to the previous point, the management of offices in other countries is controlled by one head
office located in the home country. Therefore, the source of command is found in the home country.
Continued growth: Multinational corporations keep growing. Even as they operate in other countries, they strive
to grow their economic size by constantly upgrading and by conducting mergers and acquisitions.
Sophisticated technology: When a company goes global, they need to make sure that their investment will grow
substantially. In order to achieve substantial growth, they need to make use of capital-intensive technology,
especially in their production and marketing activities.
Right skills: Multinational companies aim to employ only the best managers, those who are capable of handling
large amounts of funds, using advanced technology, managing workers, and running a huge business entity.
Forceful marketing and advertising: One of the most effective survival strategies of multinational corporations
is spending a great deal of money on marketing and advertising. This is how they are able to sell every product or
brand they make.
Good quality products: Because they use capital-intensive technology, they are able to produce top-of-the-line
products.
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Department of Economics, Gambella University, Ethiopia
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unexpected repercussions that such a discovery can have on the overall economy of a nation. Dutch disease exhibits the
following two chief economic effects: (a) It decreases the price competitiveness of exports of the affected country's
manufactured goods, and (b) It increases imports. Both phenomena result from a higher local currency. In the long run,
these factors can contribute to unemployment, as manufacturing jobs move to lower-cost countries. Meanwhile, non-
resource-based industries suffer due to the increased wealth generated by resource-based industries.
The term Dutch disease was coined by The Economist magazine in 1977 when the publication analysed a crisis
that occurred in The Netherlands after the discovery of vast natural gas deposits in the North Sea in 1959. The newfound
wealth and massive exports of oil caused the value of the Dutch guilder to rise sharply, making Dutch exports of all non-
oil products less competitive on the world market. Unemployment rose from 1.1% to 5.1%, and capital investment in the
country dropped. Dutch disease became widely used in economic circles as a shorthand way of describing the paradoxical
situation in which seemingly good news, such as the discovery of large oil reserves, negatively impacts a country's
broader economy.
In the 1970s, Dutch Disease hit Great Britain when the price of oil quadrupled, making it economically viable to
drill for North Sea Oil off the coast of Scotland. By the late 1970s, Britain had become a net exporter of oil, though it had
previously been a net importer. Although the value of the pound skyrocketed, the country fell into recession as British
workers demanded higher wages and Britain's other exports became uncompetitive. In 2014, economists in Canada
reported that the influx of foreign capital related to exploitation of the country's oil sands may have led to an overvalued
currency and a decreased competitiveness in the manufacturing sector. Simultaneously, the Russian ruble greatly
appreciated for similar reasons. In 2016, the price of oil dropped significantly, and both the Canadian dollar and the ruble
returned to lower levels, easing the concerns of Dutch disease in both countries
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Department of Economics, Gambella University, Ethiopia
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destruction of the environment. Because most foreign aid programs are designed to serve several of these purposes
simultaneously, it is difficult to identify any one of them as most important.
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