flowchart TB
IMS[International Monetary System] --> GS[Classical Gold Standard<br/>1875-1914]
IMS --> IW[Inter-war / Gold Exchange<br/>1918-1939]
IMS --> BW[Bretton Woods<br/>1944-1971]
IMS --> FL[Floating / Managed Float<br/>1973 onwards]
FL --> SDR[SDR 1969<br/>USD+EUR+RMB+JPY+GBP]
FL --> EUR[Euro 1999/2002]
classDef default fill:#003366,color:#ffffff,stroke:#ffcc00,stroke-width:3px,rx:10px,ry:10px;
34 International monetary system
34.1 Concept of the International Monetary System
The international monetary system (IMS) is the set of arrangements, institutions and rules that govern cross-border payments, exchange of currencies, and settlement of international debts. It has evolved through five broad phases: bimetallism (pre-1875), classical gold standard (1875-1914), inter-war chaos and gold exchange standard (1918-39), the Bretton Woods system (1944-71), and the present-day floating exchange-rate / managed float system (1973-). Each phase reflects a trilemma trade-off among (a) fixed exchange rates, (b) free capital mobility, and (c) independent monetary policy — a country can choose only two of the three.
34.2 Evolution of the IMS
TipFive Phases of the IMS
| Phase | Years | Features |
|---|---|---|
| Bimetallism | Pre-1875 | Gold + silver simultaneously legal tender; Gresham’s Law operated |
| Classical Gold Standard | 1875-1914 | Currencies redeemable in gold; fixed parities; automatic adjustment via gold flows |
| Inter-war / Gold Exchange Standard | 1918-1939 | Brief return to gold (1925-1931); collapsed in Great Depression; competitive devaluation |
| Bretton Woods system | 1944-1971 | USD pegged to gold ($35/oz); other currencies pegged to USD; IMF/IBRD created |
| Floating / Managed Float | 1973 onwards | Most major currencies float; many emerging-market currencies are managed floats |
34.3 Gold Standard — Classical (1875-1914)
Under the classical gold standard:
TipFeatures of Gold Standard
- Each currency had a gold parity — convertible to gold at a fixed rate.
- Mint parity between two currencies = ratio of their gold contents.
- Free import and export of gold.
-
Hume’s price-specie flow mechanism ensured automatic balance-of-payments adjustment:
- BoP surplus → gold inflow → money supply ↑ → prices ↑ → exports fall, imports rise → surplus eliminated.
- Acted as a discipline on national monetary policy.
The system collapsed in 1914 with the outbreak of World War I, when belligerents suspended gold convertibility.
34.4 Bretton Woods System (1944-1971)
The Bretton Woods Conference (July 1944, New Hampshire, 44 nations) designed the post-WWII IMS.
TipBretton Woods Architecture
- USD pegged to gold at USD 35 per ounce.
- Other currencies pegged to the USD with bands of ±1 %.
- Created the IMF (BoP support; surveillance) and the IBRD / World Bank (reconstruction lending).
- John Maynard Keynes (UK) and Harry Dexter White (US) were the architects.
- Keynes proposed an international currency unit (Bancor); rejected in favour of dollar-based system.
34.4.1 Collapse — 1971
By the late 1960s, US dollar reserves abroad far exceeded US gold reserves. President Richard Nixon on 15 August 1971 suspended dollar-gold convertibility — the Nixon Shock. The Smithsonian Agreement (December 1971) tried a wider band; failed by 1973. Floating exchange rates emerged.
34.5 Current System — Floating and Managed Float (1973 onwards)
The present non-system is variously called “managed floating” or “reference-rate” arrangement:
TipIMF’s Classification of Exchange-Rate Arrangements
- No separate legal tender — currency union / dollarisation.
- Currency board — strict peg, e.g., Hong Kong (HKD-USD).
- Conventional peg — soft peg to a single currency or basket.
- Stabilised arrangement.
- Crawling peg — gradually adjusted peg.
- Crawl-like arrangement.
- Pegged exchange rate within horizontal bands.
- Other managed arrangements.
- Floating — market-determined with intervention.
- Free floating — purely market-determined; USD, EUR, JPY, GBP, AUD, CAD, CHF.
India is classified as floating (formerly managed float); RBI intervenes to curb excessive volatility but does not target a level.
34.6 SDR — Special Drawing Right
The Special Drawing Right (SDR) is the IMF’s international reserve asset, created in 1969 to supplement member countries’ official reserves.
TipSDR — Key Facts
- Not a currency but a potential claim on freely usable currencies.
- Value determined by a basket of five currencies: USD, EUR, RMB (added 2016), JPY, GBP.
- Allocated to members in proportion to IMF quotas.
- Currency-basket reviewed every 5 years.
34.7 European Monetary System and Euro
TipEuropean Monetary Union Milestones
- European Monetary System (EMS) — 1979; Exchange Rate Mechanism (ERM) with bands.
- Maastricht Treaty 1992 — laid the framework for EMU; convergence criteria.
- European Central Bank (ECB) — established 1998; Frankfurt.
- Euro — electronic introduction 1 January 1999; physical notes and coins 1 January 2002.
- Eurozone — currently 20 member states; not all EU countries (Denmark, Sweden, Poland are EU but not Eurozone).
34.8 Impossible Trinity / Trilemma
Coined by Robert Mundell and Marcus Fleming in the 1960s. A country can have at most two of these three:
TipThe Trilemma
| Choice combination | Example |
|---|---|
| Fixed exchange rate + Free capital flow → loss of monetary independence | Hong Kong currency board, Gold-standard era |
| Fixed exchange rate + Monetary independence → capital controls | Bretton Woods era; China earlier |
| Monetary independence + Free capital flow → floating exchange rate | USA, UK, Japan, India (with managed float) |
34.9 India’s Exchange-Rate Regime — Evolution
TipIndia’s Exchange-Rate Regime History
- 1947-1971 — Rupee pegged to GBP (sterling area).
- 1971-1992 — Rupee pegged to a basket of currencies; intervention by RBI.
- 1992-93 — Partial convertibility (LERMS — Liberalised Exchange Rate Management System) — 60 % at market + 40 % at official rate.
- 1993 — Unified exchange rate.
- 1994 — Current account convertibility (IMF Article VIII).
- Present — Managed float; RBI manages volatility without targeting a level; capital account is partially convertible.
- Tarapore Committee (1997, 2006) — recommended full capital account convertibility in phases; not fully implemented.
34.10 Currency Convertibility
TipTwo Types of Convertibility
| Type | Working content |
|---|---|
| Current account convertibility | Freedom to convert for trade and current transfers — India since 1994 |
| Capital account convertibility | Freedom to convert for capital-account transactions — India partially convertible |
34.11 Practice Questions
Q 01
Bretton Woods
Easy
The Bretton Woods Conference was held in:
View solution
Correct Option: B
**July 1944**, Mount Washington Hotel, New Hampshire.
Q 02
Gold std
Medium
Under the Classical Gold Standard, automatic BoP adjustment worked via:
View solution
Correct Option: B
Surplus → gold inflow → money supply ↑ → prices ↑ → exports fall, imports rise.
Q 03
Nixon Shock
Medium
The "Nixon Shock" (15 August 1971) ended:
View solution
Correct Option: B
**Nixon suspended USD-gold convertibility** — collapse of Bretton Woods.
Q 04
USD Peg
Medium
Under Bretton Woods, the USD was pegged to gold at:
View solution
Correct Option: B
**USD 35/oz** was the official BW peg.
Q 05
Trilemma
Hard
The "impossible trinity" / trilemma says a country can have at most two of:
View solution
Correct Option: A
**Mundell-Fleming trilemma** — only two of the three policy goals are mutually consistent.
Q 06
SDR basket
Medium
Which currency is **not** in the current SDR basket?
View solution
Correct Option: C
SDR basket: **USD, EUR, RMB, JPY, GBP**. INR not yet.
Q 07
Architects
Medium
The two principal architects of the Bretton Woods system were:
View solution
Correct Option: B
**Keynes** (proposed Bancor) and **White** (US plan that prevailed).
Q 08
Euro
Medium
The Euro was introduced as physical notes and coins on:
View solution
Correct Option: B
Euro electronic 1999; **physical 1 January 2002**.
Q 09
SDR Year
Medium
The SDR was created in:
View solution
Correct Option: B
**SDR 1969**.
Q 10
India
Medium
India accepted current account convertibility under IMF Article VIII in:
View solution
Correct Option: B
India accepted **Article VIII (current account convertibility) in 1994**.
Q 11
Tarapore
Hard
The Tarapore Committee recommended:
View solution
Correct Option: B
Tarapore I (1997) and II (2006) — phased capital-account convertibility.
Q 12
India regime
Medium
India's current exchange-rate regime is best described as:
View solution
Correct Option: B
RBI intervenes to curb volatility — *managed / floating with intervention*.
Q 13
Currency board
Medium
A famous example of a *currency board* arrangement is:
View solution
Correct Option: B
**Hong Kong** — strict peg of HKD to USD.
Q 14
Smithsonian
Hard
The Smithsonian Agreement (December 1971) sought to:
View solution
Correct Option: A
**Smithsonian 1971** — wider bands (±2.25 %); failed by 1973.
Q 15
ECB
Medium
The European Central Bank is headquartered in:
View solution
Correct Option: C
**ECB — Frankfurt**.
Q 16
Phases match
Medium
Match each phase of IMS with its period:
| Phase | Period | ||
| (i) | Classical Gold Standard | (a) | 1944-1971 |
| (ii) | Bretton Woods | (b) | 1973 onwards |
| (iii) | Floating / Managed Float | (c) | 1875-1914 |
View solution
Correct Option: A
Gold 1875-1914; BW 1944-71; Floating 1973+.
Q 17
Convertibility
Medium
"Freedom to convert local currency for trade and current transfers" is:
View solution
Correct Option: B
**Current account convertibility** — India achieved in 1994.
Q 18
Mundell
Hard
The trilemma is associated with the work of:
View solution
Correct Option: B
**Mundell-Fleming model** — impossible trinity.
Q 19
Bancor
Hard
"Bancor" — a proposed international currency unit at Bretton Woods — was the idea of:
View solution
Correct Option: A
**Keynes** proposed *Bancor* — rejected in favour of dollar-based system.
Q 20
India 1991
Medium
The LERMS (Liberalised Exchange Rate Management System) was introduced in India in:
View solution
Correct Option: B
**LERMS — 1992** dual exchange rate; unified in 1993.
34.12 Quick Recall
ImportantQuick recall
- Five phases: Bimetallism (pre-1875), Classical Gold Standard (1875-1914), Inter-war Gold Exchange (1918-39), Bretton Woods (1944-71), Floating / Managed Float (1973+).
- Classical Gold Standard — Hume’s price-specie flow mechanism.
- Bretton Woods: USD pegged at $35/oz; others to USD ±1 %; created IMF + IBRD; architects Keynes (Bancor) + White; collapsed with Nixon Shock 15 Aug 1971; Smithsonian Dec 1971 failed by 1973.
- SDR (1969) — IMF reserve asset; basket = USD, EUR, RMB, JPY, GBP.
- Euro — electronic 1999, physical 2002; ECB in Frankfurt.
- Mundell-Fleming trilemma — only two of {fixed FX, free capital, monetary independence}.
- India: pegged GBP (1947-71), basket (1971-92), LERMS 1992, unified 1993, current convertibility 1994 (Article VIII); Tarapore I/II — phased capital convertibility; currently managed float.