Regional Economic Integration

Chapter 10 - The International Monetary System

The International Monetary System

Learning objectives

Be familiar with the historical development of the modern global monetary system.

Describe the role played by the World Bank and the IMF in the international monetary system. Be familiar with the differences between a fixed and a floating exchange rate system. Know what exchange rate systems are used in the world today and why countries adopt different exchange rate regimes. Understand the debate surrounding the role of the IMF in the management of financial crises.

Appreciate the implications of the global monetary system for currency management and business strategy.

This chapter discusses the evolution of the international monetary system and the implications of this system for international business, focusing on the institutional context within which exchange rates move.

The history of monetary systems includes a period with the gold standard, a fixed exchange rates system, and the current managed float system. Since WWII, the IMF and the World Bank have played an important role in the world economy

The role of the IMF is to maintain order in the international monetary system (1) to avoid a repetition of the competitive devaluations of the 1930s, and (2) to control price inflation by imposing monetary discipline on countries.

IMF-mandated macro economic policies are under serious debate, with critics charging that at times the IMF imposes inappropriate conditions on developing nations.

OUTLINE OF CHAPTER 11: THE INTERNATIONAL MONETARY SYSTEM.

Opening Case: Argentinas Monetary CrisisIntroduction

The Gold Standard

Mechanics of the Gold StandardStrength of the Gold Standard

The Period between the Wars, 1918-1939

The Bretton Woods System

The Role of the IMFThe Role of the World Bank

The Collapse of the Fixed Exchange Rate System

The Floating Exchange Rate System.

The Jamaica Agreement

Exchange Rates Since 1973

Country Focus: The U.S. Dollar, Oil Prices, and Recycling PetrodollarsFixed versus Floating Exchange Rates

The Case for Floating Exchange Rates

The Case for Fixed Exchange Rates

Who is Right?

Exchange Rate Regimes in Practice

Pegged Exchange Rates

Currency Boards

Crisis Management by the IMF

Financial Crises in the Post-Bretton Woods Era

Mexican Currency Crisis of 1995

The Asian Crisis

Evaluating the IMFs Policy Prescriptions

Country Focus: Turkey and the IMF

Implications for Managers

Currency Management

Business Strategy

Corporate-Government Relations

Management Focus: Airbus and the Euro

Chapter Summary

Critical Thinking and Discussion Questions

Closing Case: China Managed FloatCLASSROOM DISCUSSION POINTAsk students how much their currency is worth. Try to get them to identify its value in terms of another currency. Then ask students know the value of the currency. Students will probably indicate the currency kiosk at the airport posts exchange rates, or rates are printed in the newspaper, or available online.

Dig a little deeper, and try to get students to identify some of the factors that could influence the value of a currency.

Next, ask students what happens to currency values each day, and why. Try to get students to recognize the idea of a floating exchange rate system.

Finally, link this discussion to the evolution of the current international monetary system. OPENING CASE: Argentinas Monetary CrisisThe opening case explores Argentinas monetary crisis. Argentina, with its currency pegged to the U.S. dollar, went from being the darling of the international financial community in the 1990s, to defaulting on $80 billion in debt in 2001. To resolve it crisis, Argentina ultimately allowed its currency to float. Discussion of the case can revolve around the following questions. 1. How did Argentinas financial situation changed so dramatically in such a short period of time? What factors led to Argentinas currency crisis?

2. Why was the IMF criticized for its loan to Argentina?3. What effect did a floating peso have on Argentinas economy? Why?

LECTURE OUTLINE FOR CHAPTER

This lecture outline follows the Power Point Presentation (PPT) provided along with this instructors manual. The PPT slides include additional notes that can be viewed by clicking on view, then on notes. The following provides a brief overview of each Power Point slide along with teaching tips, and additional perspectives.

Slides 10-3-10-4 Introduction The international monetary system refers to the institutional arrangements that countries adopt to govern exchange rates. Governments adopt various types of exchange rate systems including the pegged rate, the dirty float and the fixed rate.Slide 10-6 The Gold Standard

The system of exchange rates known as the gold standard dates back to ancient times when gold coins were a medium of exchange, unit of account, and store of value.Slide 10-7 Mechanics of the Gold Standard

Pegging currencies to gold and guaranteeing convertibility is central to the gold standard.In the 1880s, most of the worlds trading nations followed this exchange rate system.

Slide 10-8 Strength of the Gold StandardThe gold standard provides a powerful mechanism to pull trade imbalances between countries back into balanceof trade equilibrium.Another Perspective: The Advantages Of The Gold Standard was the topic of a 1961 paper by former Federal Reserve Board Chairman, Alan Greenspan. The paper is available at {http://www.usagold.com/gildedopinion/Greenspan.html}.

Slide 10-10 The Period between the Wars, 1918-1939The gold standard worked fairly well from the 1870s until the start of World War I in 1914, but by 1939, the gold standard had collapsed.

Slides 10-11-10-12 The Bretton Woods System

The Bretton Woods system established a fixed exchange rate system where all currencies were fixed to gold, but only the U.S. dollar was directly convertible to gold. Devaluations could not to be used for competitive purposes and a country could not devalue its currency by more than 10% without IMF approval.The Bretton Woods system also provided for two multinational institutions the International Monetary Fund (IMF) and the World Bank (IBRD).

Another Perspective: For more information about the Bretton Woods Agreement go to {http://www.yale.edu/lawweb/avalon/decade/decad047.htm} and also at {http://www.econ.iastate.edu/classes/econ355/choi/bre.htm}.

Slides 10-13-10-14 The Role of the IMF

The IMF was charged with executing the main goal of the Bretton Woods agreement - avoiding a repetition of the chaos that occurred between the wars through a combination of discipline and flexibility.Another Perspective: The homepage of the IMF is available at {http://www.imf.org}. Students can click on either For First Time Visitors or on For Students to get a nice overview of the IMF and its activities.

Slide 10-15 The Role of the World BankThe World Bank is also known as the International Bank for Reconstruction and Development (IBRD).Another Perspective: For more information on the World Bank, go to {http://www.worldbank.org/index.html}. Click on Data and Research to pull information on World Bank activities, or on Countries to explore World Bank activities by country.

Slides 10-16 The Collapse of the Fixed Exchange SystemThe Bretton Woods worked well until the late 1960s, before collapsing. Slide 10-17 The Floating Exchange Rate RegimeThe Jamaica Agreement was signed in 1976 following the collapse of Bretton Woods. The rules that were agreed on then, are still in place today.Slide 10-18 The Jamaica AgreementUnder the Jamaican agreement:

floating rates were declared acceptable

gold was abandoned as a reserve asset

total annual IMF quotas were increased to $41 billion

Slide 10-19 Exchange Rates since 1973Exchange rates have become more volatile and less predictable than they were between 1945 and 1973.Slide 10-22 Fixed Versus Floating Exchange RatesThe merit of a fixed exchange rate versus a floating exchange rate system continues to be debated.

Slides 10-23-10-24 The Case for Floating Exchange Rates

The case for floating exchange rates has two main elements:

1. monetary policy autonomy

2. automatic trade balance adjustments

Slide 10-25 The Case for Fixed Exchange RatesSupporters of fixed exchange rates focus on monetary discipline, uncertainty, and the lack of connection between the trade balance and exchange rates.Slide 10-26 Who is Right?There is no real agreement as to which system is better.

Slides 10-27-10-28 Exchange Rate Regimes in PracticeCurrently:

14% of IMF members follow a free float policy

26% of IMF members follow a managed float system

28% of IMF members have no legal tender of their own

the remaining countries use less flexible systems such as pegged arrangements, or adjustable pegs

Slide 10-30 Pegged Exchange RatesA country following a pegged exchange rate system, pegs the value of its currency to that of another major currency.Slide 10-31 Currency BoardsCountries using a currency board commit to converting their domestic currency on demand into another currency at a fixed exchange rate.Slide 10-32 Crisis Management by the IMFToday, the IMF focuses on lending money to countries experiencing financial crises.Slide 10-33 Financial Crises in the Post-Bretton Woods EraA currency crisis occurs when a speculative attack on the exchange value of a currency results in a sharp depreciation in the value of the currency, or forces authorities to expend large volumes of international currency reserves and sharply increase interest rates in order to defend prevailing exchange rates.A banking crisis refers to a situation in which a loss of confidence in the banking system leads to a run on the banks, as individuals and companies withdraw their deposits.A foreign debt crisis is a situation in which a country cannot service its foreign debt obligations, whether private sector or government debt.

Slide 10-35 Mexican Currency Crisis of 1995The Mexican currency crisis of 1995 was a result of:

high Mexican debts

a pegged exchange rate that did not allow for a natural adjustment of prices

Slides 10-36-10-38 The Asian CrisisThe 1997 Southeast Asian financial crisis was caused by a series of events that took place in the previous decade.Slide 10-39 Evaluating the IMF Policy Prescriptions

Critics of the IMF worry:

the one-size-fits-all approach to macroeconomic policy is inappropriate for many countries

the IMF is exacerbating moral hazard (when people behave recklessly because they know they will be saved if things go wrong)

The IMF has become too powerful for an institution without any real mechanism for accountability

Slide 10-40 Implications for ManagersThe present floating rate system mandates that firms carefully manage their foreign exchange transactions and exposures.

Slide 10-41 Currency ManagementManagers must recognize that the current international monetary system is a managed float system in which government intervention can help drive the foreign exchange market.

Slide 10-42 Business Strategy

Managers need strategic flexibility.Slide 10-43 Corporate Government RelationsCompanies should promote an international monetary system that facilitates international growth and development.

CRITICAL THINKING AND DISCUSSION QUESTIONS

QUESTION 1: Why did the gold standard collapse? Is there a case for returning to some type of gold standard? What is it?

ANSWER 1: The gold standard worked reasonably well from the 1870s until the start of World War I in 1914, when it was abandoned. During the war several governments financed their massive military expenditures by printing money. This resulted in inflation, and by the war's end in 1918, price levels were higher everywhere. Several countries returned to the gold standard after World War I. However, the period that ensued saw so many countries devalue their currencies that it became impossible to be certain how much gold a currency could buy. Instead of holding onto another country's currency, people often tried to exchange it into gold immediately, lest the country devalue its currency in the intervening period. This put pressure on the gold reserves of various countries, forcing them to suspend gold convertibility. As a result, by the start of World War II, the gold standard was dead.

The great strength of the gold standard was that it contained a powerful mechanism for simultaneously achieving balance-of-trade equilibrium by all countries. This strength is the basis for reconsidering the gold standard as a basis for international monetary policy.

QUESTION 2: What opportunities might current IMF lending policies to Third World nations create for international businesses? What threats might they create?

ANSWER 2: The IMF lending policies require the recipient countries to implement governmental reforms to stabilize monetary policy and encourage economic growth. One of the principal ways for a developing nation to spur economic growth is to solicit foreign direct investment and to provide a hospitable environment for the foreign investors. These characteristics of IMF lending policies work to the advantage of international businesses that are looking for investment opportunities in developing countries.

QUESTION 3: Do you think the standard IMF policy prescriptions of tight monetary policy and reduced government spending are always appropriate for developing nations experiencing a currency crisis? How might the IMF change its approach? What would the implications be for international business?

ANSWER 3: Critics argue that the tight macroeconomic policies imposed by the IMF in the recent Asian crisis are not well suited to countries that are suffering not from excessive government spending and inflation, but from a private-sector debt crisis with inflationary undertones. Anti-inflationary monetary policies and reductions in government spending usually result in a sharp contraction of demand, at least in the short run. In the longer term, the policies can promote economic growth and expansion of demand, which creates opportunities for international business.

QUESTION 4: Debate the relative merits of fixed and floating exchange rate regimes. From the perspective of an international business, what are the most important criteria for choosing between the systems? Which system is the more desirable for an international business?

ANSWER 4: The case for fixed exchange rates rests on arguments about monetary discipline, speculation, uncertainty, and the lack of connection between the trade balance and exchange rates. In terms of monetary discipline, the need to maintain fixed exchange rate parity ensures that governments do not expand their money supplies at inflationary rates. In terms of speculation, a fixed exchange rate regime precludes the possibility of speculation. In terms of uncertainty, a fixed rate regime introduces a degree of certainty in the international monetary system by reducing volatility in exchange rates. Finally, in terms of trade balance adjustments, critics question the closeness of the link between the exchange rate and the trade balance. The case for floating exchange rates has two main elements: monetary policy autonomy and automatic trade balance adjustments. In terms of the former, it is argued that a floating exchange rate regime gives countries monetary policy autonomy. Under a fixed rate system, a countrys ability to expand or contract its money supply as it sees fit is limited by the need to maintain exchange rate parity. In terms of the later, under the Bretton Woods system, if a country developed a permanent deficit in its balance of trade that could not be corrected by domestic policy, the IMF would agree to a currency devaluation. Critics of this system argue that the adjustment mechanism works much more smoothly under a floating exchange rate regime. They argue that if a country is running a trade deficit, the imbalance between the supply and demand of that countrys currency in the foreign exchange markets will lead to depreciation in its exchange rate. An exchange rate depreciation should correct the trade deficit by making the countrys exports cheaper and its imports more expensive. It is a matter of personal opinion in regard to which system is better for an international business. We do know, however, that a fixed exchange rate regime modeled along the lines of the Bretton Woods system will not work. Nevertheless, a different kind of fixed exchange rate system might be more enduring and might foster the kind of stability that would facilitate more rapid growth in international trade and investment.

QUESTION 5: Imagine that Canada, the US, and Mexico decide to adopt a fixed exchange rate system. What would be the likely consequences of such a system for (a) international businesses, and (b) the flow of trade and investment between all three countries?

ANSWER 5: Were North America to adopt a common currency, it would become increasingly attractive for foreign investment and would increase trade and investment among the three countries.

The exchange rates between Canada and the U.S. have been relatively stable for a long time, but that is not the case with Mexico, as the text explains (Mexican currency crisis of 1995). Trade and investment flows between the U.S. and Mexico would increase both ways, as would they between Canada and Mexico. Mexico would become more attractive to FDI, especially as a location for production for the North American marketQUESTION 6: Reread the Country Focus on the U.S. dollar, oil prices and recycling petrodollars, then answer the following questions:

a) What will happen to the value of the U.S. dollar if oil producers decide to invest most of their earnings from oil sales in domestic infrastructure projects?

b) What factors determine the relative attractiveness of the dollar, euro, and yen denominated assets to oil producers flush with petrodollars? What might lead them to direct more funds towards non-dollar denominated assets?

c) What will happen to the value of the dollar if OPEC members decide to invest more of their petrodollars towards non-dollar assets, such as euro denominated stocks and bonds?

d) In addition to oil producers, China is also accumulating a large stock of dollars, currently estimated to total $1,000 billion by the end of 2006. What would happen to the value of the dollar if China and oil producing nations all shifted out of dollar denominated assets at the same time? What would be the consequences for the United States economy?

ANSWER 6: a) If oil producers decide to invest their earnings in domestic infrastructure projects, it would be expected that the countries involved would see a boost in economic growth, and an increase in imports. This would put downward pressure on the dollar as the petrodollars are sold, or are invested in the local community, however the expected increase in imports that should result from greater economic growth would increase the demand for dollars.

b) The relative attractiveness of an investment whether it is denominated in dollars, euro, or yen depends on expected returns and the degree of risk associated with the investment. When considering different currencies, it would be important to consider expected shifts in the exchange rate. So, for example, if the dollar was expected to depreciate relative to the euro or yen, non-dollar denominated assets might be more attractive all else being equal.

c) Oil producers have significantly increased their holdings of dollars as a result of higher oil prices. Should OPEC members decide to sell their dollars to invest in non-dollar denominated assets such as euro denominated stocks or bonds, we would expect to see downward pressure on the dollar.

d) If China and the oil producers simultaneously decide to sell off their dollars, there would be significant downward pressure on the dollar. This downward pressure would probably cause considerable pessimism among investors, and the U.S. economy, and the world economy in general, would likely suffer.

CLOSING CASE: Chinas Managed Float

The closing case describes feature describes Chinas exchange rate policy. For nearly a decade, China fixed its exchange rate to the dollar and bought or sold dollars to maintain the exchange rate. By early 2005 though, the country was feeling pressure both at home and abroad to let its currency, the yuan, float freely against the dollar. The following questions can be helpful in directing the discussion:

QUESTION 1: Why do you think the Chinese government originally pegged the value of the yuan against the U.S. dollar? What were the benefits of doing this to China? What were the costs?

ANSWER 1: Most of the Chinese exports are made from dollar-denominated imported materials and energy. By pegging to the dollar, China managed its foreign exchange risk in these areas. It also mitigated the risk for investors coming into China. Also, Chinas economy, through its peg to the dollar, has remained stable. It was not drawn into the Asian meltdown in 1997. One of the costs of pegging is that the Chinese government has to manage the peg. Thus, it is active in the foreign exchange markets. Another cost is that the dollars movement, up or down, affects the Chinese economy.

QUESTION 2: Over the last decade, many foreign firms have invested in China, and used their Chinese factories to produce goods for export. If the yuan is allowed to float freely against the U.S. dollar on the foreign exchange markets, and appreciates in value, how might this affects the fortunes of those enterprises?

ANSWER 2: Since they are moving raw materials into China, using Chinese labor, and then exporting, their production costs will rise in China (yuan strengthening against the dollar) in dollar terms. The value of their investment in China will increase as the dollar weakens. Selling into the Chinese market may become more attractive to substitute for exports. If the core production strategy for their Chinese operations is to use relatively low-cost labor, that will no longer be possible unless productivity increases. They may consider moving to another low-cost labor market.

QUESTION 3: How might a decision to let the yuan float freely affect future foreign direct investment flows into China?

ANSWER 3: If the yuan appreciates against the dollar, FDI may be a more costly venture. Even so, a company may still find it advantageous to set up an operation in China, particularly if the company also plans to sell its product locally.

QUESTION 4: Under what circumstances might a decision to let the yuan float freely destabilize the Chinese economy? What might the global implications of this be?

ANSWER 4: Chinas undervalued yuan is fueling a boom in Chinese exports to the U.S., where jobs are being lost to the cheap Chinese imports. For its part, China is facing the potential for a surge in inflation as the country expands the money supply in an effort to maintain the artificial Yuan/dollar relationship. Many students will probably suggest that if the yuan is allowed to float, China will see some of its manufacturing slow as companies lose the benefit of cheap yuan exports. This could then translate into a slowing economy. Other students may note that a stronger yuan would give the Chinese more buying power, which might benefit foreign producers. Still other students may bring up the huge foreign exchange reserves currently being held by China, and how a floating yuan might affect the reserves. QUESTION 5: Do you think the U.S. government should push the Chinese to let the yuan float freely? Why?

ANSWER 5: China was being pressured to allow a floating yuan/dollar relationship because there of a belief that, after years of rapid economic growth, the pegged exchange rate undervalued the true value of the yuan by as much as 40 percent. Many students will probably agree with this perspective. However, other students may point out that consumers in the United States benefit from the pegged yuan. QUESTION 6: What do you think the Chinese government should do? Let the float, maintain the peg, or change the peg in some way?

ANSWER 6: In 2005, China finally caved in and announced that it would link its currency to a basket of currencies that include the U.S. dollar, the euro, and the yen. Along with its new system, China also agreed to revalue the yuan against the U.S. dollar by 2.1 percent, and to let the yuan float by 0.3 percent per day against the dollar and 1.5 percent per day against other currencies. Many economists felt that while these moves were a good start, more needed to be done. In fact, some U.S. senators felt that a 27.5 percent tariff should be imposed on all Chinese imports unless the yuan was further depreciated relative to the dollar.Another Perspective: Students can track the yuan since 2005 by going to {http://www.oanda.com/convert/fxhistory}. Click on FX history and then enter the dates and currencies you want to see.

INTEGRATING iGLOBESThere are several iGLOBE video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following:

Title: New World Bank Chief Zoellick Tasked With Reputation Repair

Zoellick Discusses World Bank

Run Time: 11:48

Abstract: This video explores how the new head of the World Bank, Robert Zoellick, is getting the institution back on track, and the challenges that lie ahead for the institution.

Key Concepts: World Bank, globalization, levels of economic development, corruption, poverty

Notes: One hundred days into his reign as World Bank President, Robert Zoellick is optimistic about the World Banks future. Zoellick, who took on the leadership position of the institution following the departure of the often criticized Paul Wolfowitz, has spent three months restoring faith in the organization. The World Bank had been the recipient of significant criticism recently, particularly during the last part of Wolfowitzs leadership. One key area that is continuing to plague the organization is corruption in countries like Nigeria and the Philippines. Zoellick believes that the World Bank needs to continue to fight corruption, and has stressed the need for transparency in nations receiving aid. Zoellick also believes that the World Bank should embrace globalization without leaving the worlds poorer nations behind. He is currently focusing on raising money to create a fund for the worlds poorest countries.

The World Bank was founded in 1944. Its purpose at the time was to help rebuild a war-torn Europe. Today, the World Bank has evolved into the worlds largest poverty-fighting institution, lending about $24 billion annually to nations in Africa, Asia, and Latin America. Zoellick believes that to continue in its role as a leader in poverty relief, the organization must change to fit with the changing global environment. Rather than being a stand alone entity that simply provides loans, Zoellick believes the institution should work together with organizations like the Gates Foundation to coordinate aid efforts. Zoellick believes that customizing aid packages and other services to the particular situation in a country will be vital in the future. He notes for example, that China is taking advantage of the World Banks knowledge of environmental issues, but that World Bank services in a country like Ghana would be entirely different. One of the goals Zoellick has proposed is to identify how the World Bank can improve its role as a knowledge and learning institution. He notes that the institutions public and private sides need to be coordinated so that the whole is greater than the sum of the parts. Zoellick also argues that the World Bank needs to continue to offer its services to so-called middle income countries like India, China, and Brazil. Some critics have argued that these countries should no longer receive World Bank monies because they have their own resources. Zoellick however, argues that since about 70 percent of the worlds poor lives in these countries, the World Bank must remain involved. He also notes maintaining close ties with these countries is more important than ever as they become bigger players in Africa.

Discussion Questions:

1. What do you see as the main challenges for the World Bank today?

Answer: When Robert Zoellick was appointed to lead the World Bank, he spent the first part of his tenure restoring confidence in the institution. Many students will probably suggest that the institution must continue to earn respect in the world, and earn the right to lead the world in fighting poverty. To that end, some students will probably suggest that transparency in all dealings is essential. Other students may also point out that the World Bank must continue to move away from being a single solution institution, and toward becoming the type of institution that can work with a variety of public and private organizations to provide coordinated, customized solutions for countries in need.

2. How has the World Bank evolved since its inception in 1944?

Answer: When the World Bank was initially conceived in 1944, it was charged with helping to rebuild war-torn Europe. Over time, the World Bank evolved to become a source of loans to countries in need of infrastructure improvements. Today, the organization has become not only a source of loans, but also a source of knowledge and expertise. The World Bank lends some $24 billion each year to countries in Africa, Asia, and Latin America. World Bank President Robert Zoellick believes the institution now must embrace globalization, yet be careful not to leave the poor behind.

3. Reflect on the World Bank as a knowledge and learning institution. In your opinion, is there a need for this type of institution? Why or why not?

Answer: The World Bank is now being seen as not just a source of loans, but also as a source of knowledge and learning. China, for example, is getting assistance from the World Bank on environmental issues. Similarly, the World Bank has indicated that it might get involved in Chinas health care. Most students will probably agree that an institution offering this type of information could be very beneficial to poor nations that may have few alternative sources of information. Some students might point out that the by teaching countries how to grow, the World Bank can go beyond simply being a money lending institution. In Africa, for example, the World Bank is helping with micro-financing, and in China, the focus is on combining growth with environmental safety.

4. Discuss the notion of the World Bank as a facilitator or liaison between the public and private sectors, between aid organizations, and so forth. What unique qualities does the World Bank possess that would help it in this type of role?

Answer: Poverty has been receiving more attention recently, thanks in part to the efforts of various well-known individuals who are publicizing the plight of the poor. Bill Gates for example, has established the Gates Foundation which is working to help relieve poverty in places like Africa. Most students will probably suggest that the World Bank is uniquely qualified to help coordinate these efforts. The World Bank has been working with the governments of many poor countries for years, and not only has a wealth of knowledge about the situation in different countries, but also the global leadership position to bring these efforts together. Some students may suggest that by working together these efforts can be more beneficial than they could be independently.

INTEGRATING VIDEOS

There are also several longer video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following:

Title 10: Tough JobSummary

The International Monetary Fund (IMF) was established at the end of World War II in Bretton Woods, New Hampshire, to help Europe and the world economy recover from war and depression. More recently, the IMFs role has changed to that of a lender of last resort to countries in economic distress. With this change has come a host of accusations suggesting that recipients of IMF loans have been required to cut back on spending for the poor. Newly appointed head of the IMF, Rodrigo Rato, denies these accusations. Rato defends the IMFs actions arguing that the IMF simply stepped in to help countries when no one else would. He suggests that spending cutbacks required by the IMF were not directed at the poor, rather they were simply an effort to rein in government spending and get a country on a budget. Rato has also stated that he believes in forgiving debt held by the very poorest nations so long as they follow an IMF program to stay fiscally on track. Furthermore, Rato suggests that while the U.S. may not be a recipient of IMF aid, it is important for the U.S. to understand its mission, both from an ethical standpoint, and because as citizens of the global economy, the U.S. stands to gain from less prosperous economies. In other words, the American economy needs the world, and the world needs the American economy. Rato has also called on the U.S. to reduce its debt, fearing that the country will not be able to carry such a burden in the longer term.

Discussion Questions1. Consider the role of the IMF today as compared to its role when it was first established. In which situation has the IMF been more successful? Why?

2. The IMF has come under considerable fire from those who believe that its actions target the poor. What alternatives, if any, are available to the countries that have requested IMF aid? What would happen to the poor in these nations if the IMF had not stepped in? How would you respond to these critics?

3. IMF head, Rato, has called on the U.S. to not only understand the mission of the IMF, but also to reduce its own debt load. Why do you think Rato has chosen to make these statements?

4. There is some movement toward forgiving debt held by the very poorest nations in the world. The IMFs position would seem to be that this is appropriate so long as the countries in question agree to an IMF program to maintain their recovery. Do you agree with this plan? Would this type of assistance help make these countries more productive members of the global economy? Why or why not?

globalEDGE Exercise Questions

Use the globalEDGE site {http://globalEDGE.msu.edu/} to complete the following exercises:Exercise 1

The quality of life in emerging markets sometimes is impacted by the countrys financial and fiscal policies. As such, the Global Financial Stability Report is a semi-annual report published by the International Capital Markets division of the International Monetary Fund (IMF). The report aims to provide a regular assessment of global financial markets and to identify potential systemic weaknesses that could lead to crises. Locate and download the latest report to prepare a summary of what the IMF sees as the developments and vulnerabilities facing emerging market countries.

Exercise 2

An important element to understanding the international monetary system is keeping updated on current growth trends worldwide. A German colleague told you yesterday that Deutsche Bank Researchs Megatopics are an effective way to stay informed on important topics in international finance. Find a Megatopics report focusing on global growth centers. Which country (or countries) is included in your report? Is the report on established or emerging economies? What are the key takeaways from your chosen report?

Answers to the ExercisesExercise 1

The reports are accessible by searching for the phrase Global Financial Stability Report at {http://globaledge.msu.edu/ResourceDesk/}. This resource is located under the globalEDGE category Money: Finance. Be sure to check the Resource Desk only checkbox of the search function on the globalEDGE website.Search Phrase: Global Financial Stability ReportResource Name: IMF: Global Financial Stability Report

Website: {http://www.imf.org/external/pubs/ft/GFSR/index.htm} globalEDGE Category: Money: Finance

Exercise 2

The Megatopics reports are accessible by searching for the phrase Deutsche Bank Research at {http://globaledge.msu.edu/ResourceDesk/}. This resource is located under the globalEDGE category Money: Finance. After clicking the English button at the top right of the webpage, the Megatopics reports are located to the lower right of the screen. The special topic of Global Growth Centres is found toward the bottom. Be sure to check the Resource Desk only checkbox of the search function on the globalEDGE website.

Search Phrase: Deutsche Bank Research

Resource Name: Deutsche Bank Research

Website: {http://www.dbresearch.de/}globalEDGE Category: Money: Finance

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