Question

How will the international monetary system continue to evolve as time progresses?

please explain

Answer 1

The ultimate goal of the international monetary system is to maintain an orderly system of payments among nations. To this aim, the IMS has to provide the services of an international currency, ensure adequate creation of global liquidity, define an exchange rate regime among national currencies and include an adjustment mechanism to avoid excessive external real and financial imbalances across nations.

The exchange rate and capital flow regimes are probably the core elements of the adjustment mechanism, since they define the degree of flexibility of each IMS, i.e. its adaptability to changing economic circumstances. In contrast to the Bretton Woods system with fixed exchanges rates, semi-closed capital accounts and a strict adjustment mechanism, an IMS such as the present one enjoys a much higher degree of adaptability. Each country is free to choose its exchange rate and capital account regime, and the reserve-issuing countries face no IMS-embedded limits to the creation of global liquidity. This is a fundamental strength of today’s system, but it may also become – as we will see – a major weakness to the extent that it creates scope for unsustainable domestic growth models and the ensuing accumulation of real and financial imbalances.

The euro has established itself as the second most important international currency after the US dollar. At the same time, this role is predominantly regional in nature, since the euro is mainly used by economic agents resident in euro area neighbouring countries with special political and economic ties to the European Union and the euro area. More recently, it is known that Asian investors and foreign central banks accounted for a sizable share of the demand for bonds issued by the European Financial Stability Facility

Looking ahead, the share of the euro in international markets has the potential to rise further once financial stability and market integration is restored in the euro area. The ongoing efforts to improve the governance of the euro area and provide it with a credible crisis resolution mechanism will also indirectly affect the international use of the euro, even if the ECB and the Eurosystem do not take any initiatives to directly promote its use

It remains to be seen whether the currency competitors of such a multi-polar world will be of relatively close weight, both in economic and financial terms, but also with respect to the political and governance factors discussed before when considering the preconditions for a currency to become a major international currency.

As regards the necessary changes to international cooperation, we will need to see a greater awareness among global partners about their interlinkages and the ensuing responsibilities to ensure the stability of the whole system. I am convinced that, without a minimum spirit of multilateralism and a minimum degree of cooperation, no future IMS will remain stable for long. It is to be hoped that countries, especially those with systemic relevance, understand that it is in their best self-interest to consider externalities and cooperate. But such “enlightenment” alone will not be sufficient to ensure stability. If the IMS as such does not deliver the right incentives, the international community will have to eventually agree on enhanced adjustment mechanisms, e.g. in order to foster the traction of policy recommendations. It is to be hoped that we do not need another global crisis to instil the necessary incentives.