The International Monetary System in the 2020s (KAWAI Masahiro)
Changes in the International Monetary System: Exchange Rate Systems and the Impossible Trinity (ITO Hiroyuki, KAWAI Masahiro)
Will the U.S. Dollar Continue to Dominate? (SAKURAGAWA Masaya)
The Yen as an International Currency (NAKASO Hiroshi, HASHIMOTO Masahiko)
Relationship Between the Renminbi Internationalization Strategy and the Digital Yuan, and the Future Outlook (SEKINE Eiichi)
Exchange Rate Regimes and Economic Stability of Emerging Economies: The Role of Inflation Targeting (FUKUDA Shin-ichi)
IMF in the International Monetary System ― Globalization and Fragmentation ― (ARIYOSHI Akira)
| By KAWAI Masahiro | (Senior Fellow, Policy Research Institute, Ministry of Finance and Professor Emeritus, University of Tokyo) |
The post-World War II international monetary system has undergone significant transformations since the “Nixon shock” in 1971. First, major developed countries moved from the fixed exchange rate system they had adopted until then, known as the
IMF-Bretton Woods System that set the U.S. dollar as the key currency, to a floating exchange rate system from 1973. Second, the international monetary system underwent another transformation in 1999, by evolving into a multiple-key currency system when 11 Western European countries created their common currency, the euro. Despite the onset of the 2007-09 global financial crisis that originated in the United States, the central country of the international monetary system, the function of the U.S. dollar as the dominant international currency was not seriously impaired. The institutional vulnerability of the euro became apparent during the European financial crisis that spanned from 2010 to 2015, suggesting that it would not be easy for the euro to assume a role comparable to the U.S. dollar on a global scale. Third, following the global financial crisis, China began to actively promote the internationalization of its currency (yuan or renminbi) against the backdrop of its growing economic and financial power, engaging in competition to counter the currency and financial hegemony of the United States. Russia, too, demonstrated a stronger inclination toward de-dollarization and greater use of the renminbi due to financial sanctions imposed after its military aggression against Ukraine in 2022. However, for the renminbi to become a full-fledged international currency, China needs to have free international capital flows and an open, deep, and highly liquid renminbi-denominated financial market, which is likely to take considerable time to establish.
This paper first classifies the various types of international monetary systems into three groups, and it then explains the characteristics of each: the fixed exchange rate system, the floating exchange rate system, and the coordinated currency system (such as the European Monetary System (EMS) and the Economic and Monetary Union (EMU) of the euro). Next, it discusses the key pillars of the international monetary system, i.e., currency convertibility, exchange rate systems, monetary policy frameworks, international currencies, and the global financial safety net. Furthermore, it analyzes the key aspects of the international monetary system such as global imbalances and the U.S. current account deficit, the euro and the European financial crisis, financial and debt crises in developing countries, the internationalization of the renminbi, and central bank digital currencies. Lastly, it presents four potential future scenarios for the international monetary system (a renewed U.S. dollar-based system, a global reserve currency system, a multipolar international monetary system, and a fragmented international monetary system), and discusses challenges for the United States, the Euro Area, and Asia, and the risk of international monetary system fragmentation.
Keywords: International monetary system, currency convertibility, global financial safety net, global imbalance, Economic and Monetary Union (EMU), internationalization of the renminbi, financial and debt crisis, central bank digital currency, monetary and financial cooperation in Asia, fragmentation of the international monetary system
JEL Classification: F31, F32, F33, F34, F38, F42
| By ITO Hiroyuki | (Professor of Economics, Portland State University, and Visiting Fellow, Research Institute of Economy, Trade and Industry) |
| By KAWAI Masahiro | (Senior Fellow, Policy Research Institute, Ministry of Finance and Professor Emeritus, University of Tokyo) |
This paper focuses on exchange rate systems and the “Impossible Trinity” (trilemma) of international macroeconomics to shed light on changes in the international monetary system. The exchange rate system is determined by the degree of exchange rate fluctuations and the anchor currency for exchange rate stabilization. The trilemma comprises exchange rate stability, financial market openness, and the degree of monetary policy independence. In this paper, we use the traditional Frankel-Wei (1996) framework and its modified version, the Kawai-Pontines (2016) model. By doing so, we not only obtain the index of exchange rate stability (based on the root mean square error (RMSE) of the estimates), but also identify the anchor currencies for each country. The openness of a financial market can be measured by the ratio of the sum of a country’s external assets and external liabilities to GDP and or trade. The extent of monetary policy independence can be expressed by how a country’s short-term interest rate responds to foreign short-term interest rates and domestic and foreign economic factors (such as GDP gap, inflation rate, and foreign output growth rate, and crude oil prices). all of the three indices are normalized between 0 and 1.
Analyzing exchange rate systems for more than 100 countries, we identify the scale and changes in major currency zones (such as the U.S. dollar zone, Eurozone, British pound zone, Japanese yen zone, and Chinese Renminbi zone) as well as the economic areas that adopt a flexible exchange rate system. Furthermore, by locating the three policy indexes in a trilemma triangle, we also intuitively illustrate how the combinations of the three policies have evolved over time. This paper yields several insightful findings.
Firstly, while the U.S. dollar zone continues to dominate the largest share in the global economy, in recent years, it is showing a declining trend with the emergence of the Eurozone and the rapid rise of the Renminbi zone. At the same time, the global share of economic areas that use the floating exchange rate system is expanding. Secondly, with some exceptions in the Eurozone, both developed and emerging or developing countries have adopted a trilemma combination of increasing levels of exchange rate flexibility and financial openness. More recently, there is a growing trend among both developed and emerging or developing countries to adopt the "corner regime," which maintains a flexible exchange rate system, open financial markets, and independent monetary policy. In contrast, no developed countries have adopted a "corner regime" with stable exchange rates, closed financial markets, and independent monetary policy. While some developed countries, such as those in the Eurozone, have adopted a "corner regime" with a stable exchange rate, open financial markets, and the abandonment of independent monetary policy, only few emerging or developing countries have opted for such a trilemma combination. Rather, many countries have chosen other combinations than the three "corner regimes,” i.e., "middle-ground regime”). Thirdly, there is no trilemma system that yields the best macroeconomic performance for both developed and emerging or developing countries.
Keywords: Exchange rate systems, trilemma of international finance, exchange rate stability, openness of financial markets, independence of monetary policies, trilemma system, macroeconomic performance
JEL Classification: F15, F21, F31, F36, F41, O24
| By SAKURAGAWA Masaya | (Professor, Faculty of Economics, Keio University) |
This paper consists of two main parts. In the first half, I explain the history of how the U.S. dollar acquired and maintained its monopoly position as an international currency. In the second half, I examine whether China, which has emerged as a challenger to the United States, may threaten the currency hegemony of the United States, and explore the future of the international monetary system.
Keywords: International currency, foreign exchange reserves, China’s housing bubble, crisis in Ukraine
JEL Classification: F33, F45, F51
| By ITO Sayuri | (Executive Director, Economic Research Department, NLI Research Institute) |
Since its introduction in 1999 till the present day, the Euro has maintained its position as the second most important international currency after the U.S. dollar.
The most significant feature of the Euro is the mismatch between fiscal sovereignty and monetary sovereignty, and the integration of Europe, which forms the foundation of the Euro, provides some room for changes through deepening and regional expansion. Crises in the past have served as driving forces for integration. During the COVID-19 pandemic, the EU and its member countries, drawing lessons from the Eurozone crisis, established frameworks for fiscal stimuli and realized the creation of the Next Generation EU fund for economic recovery.
Recovery Fund." The European Central Bank (ECB) played a role in putting the brakes on the chain reaction of debt crises during the Eurozone crisis and supporting fiscal stimuli during the COVID-19 pandemic. The number of countries that have adopted the Euro has expanded from the initial 11 to 20 countries. Since 2018, there has been a growing emphasis on strengthening its role as an international currency.
The Euro currently faces a security crisis in the form of Russia's military aggression against Ukraine, as well as the accompanying energy crisis. The Euro has been utilized as one of the means for imposing sanctions on Russia. However, the shift in EU's relationship with Russia, from interdependence to confrontation, does not provide a tailwind for bolstering its role as an international currency.
The current crisis could develop to become source of concern regarding the sustainability of the Euro, as well as become an opportunity for promoting deeper integration and expansion. On the policy front, enhancing defense capabilities, energy security, and economic security have become priorities, but there is little momentum toward significantly strengthening common financial resources in the same way that the region responded to the COVID-19 pandemic. There is also a risk that political confrontation may sharpen in response to energy crisis measures.
Unlike in its response to past crises, the ECB is now taking swift steps towards the normalization of monetary policy with a view to achieving its main objective of medium-term price stability, and is even moving toward further tightening. The current ECB possesses tools to address the fragmentation caused by widening yield spreads, but there are limits to the role it can play in asymmetric shocks such as the energy crisis. Hence, there is a need for coordinated efforts at the political level.
As for the outlook, it is difficult to foresee Ukraine's EU membership and adoption of Euro in the near future. However, the EU and the Euro are likely to play significant roles in Ukraine's recovery. As shown by its efforts towards the realization of a Digital Euro, EU is maintaining the policy of pursuing strategic autonomy by enhancing the role of the Euro.
Going forward, it is likely that repeated efforts will be made to reach the political agreements required to safeguard the Euro, and that the Euro will strengthen its position as the key currency of Europe. On the other hand, with the retreat of globalization, the expansion of the Euro's international role beyond Europe is expected to be limited.
Even as the world becomes increasingly fragmented, the Euro is likely to remain as the international currency that ranks second after the U.S. dollar and surpasses the Renminbi. However, the gap between the Euro and the Renminbi is likely to narrow steadily.
Keywords: International currency, key currency, European Union (EU), European Central Bank (ECB), Stability and Growth Pact (SGP), recovery fund “NextGenerationEU,” economic sanctions, financial sanctions, EU enlargement, enlargement of the euro area, strategic autonomy, Central Bank Digital Currencies (CBDC)
JEL Classification: E58, E60, F02, F50, H63
| By NAKASO Hiroshi | (Chairman, Daiwa Institute of Research; Chairman, The Organization of Global Financial City Tokyo (FinCity Tokyo)) |
| By HASHIMOTO Masahiko | Senior Economist, Daiwa Institute of Research |
While the role of the Japanese yen as an international currency has not grown dramatically, it has maintained a stable position compared to the relative decline in the size of the Japanese economy. Furthermore, after the global financial crisis, Japanese banks have become the largest cross-border intermediaries in the global financial market, where the U.S. dollar remains the dominant key currency. In addition, the establishment of the central banks’ dollar swap lines, which ensures the conversion of major currencies, including the yen, to dollars even in times of emergency, has reinforced the yen's position as an international currency that complements the international currency system based on the U.S. dollar as the key currency. While the role of the U.S. dollar as the key currency seems unlikely to diminish in the foreseeable future, it is difficult to anticipate the yen’s presence as an international currency growing independently. Nevertheless, given the role the yen performs currently, it will continue fulfilling a certain role as an international currency. Moreover, the ongoing “Tokyo Financial Center Initiative” will contribute to elevating the yen's role as an international currency. Ensuring better access to Japan’s financial markets for domestic and foreign companies contributes to the sustainable economic development of the Asia Pacific region by supporting funding activities for companies in the region. For the yen to continue to effectively perform its function as an international currency, Japan faces the challenges of upgrading core infrastructure such as payment and settlement systems and diversifying funding means in the Tokyo market. To realize the sustainable development of the Japanese economy, it is necessary to respond appropriately to overcome the challenges by capturing the roles of Japanese financial institutions, the yen, and global financial center in a comprehensive and collective manner.
Keywords: Internationalization of the Japanese yen, central banks’ dollar swap lines, international financial center
JEL Classification: F31, G15, G20
| By SEKINE Eiichi | (Chief Representative, Beijing Representative Office, Nomura Institute of Capital Markets Research) |
China's internationalization of the Renminbi began in the aftermath of the global financial crisis in September 2008 with the introduction of Renminbi-denominated trade settlement in July 2009. It was strategically advanced with a view to the inclusion of the Renminbi in the International Monetary Fund's (IMF) Special Drawing Rights (SDR) basket, which came about in 2015. During this time, China continued to promote the internationalization of the Renminbi through a unique approach that included the establishment of Renminbi clearing banks, concluding Renminbi-denominated currency swap agreements, allocating
Renminbi-denominated investment quotas for Qualified Foreign Institutional Investors (RQFII), and establishing the Stock Connect scheme, a mutual transaction system with Hong Kong for cross-border securities investment. After the exchange rate reform of August 2015, China experienced a temporary capital outflow, but the policy of Renminbi internationalization remained unchanged, and it continued to make efforts to improve the cross-border securities transaction system. As for digital Yuan, although it has been primarily used in the domestic retail sector, joint research efforts are also underway toward application in the area of international settlements. In the future international monetary system, China’s strategy is to strengthen the Renminbi’s presence within the frameworks of institutions such as the IMF and regional financial cooperation. However, to further advance the internationalization of the Renminbi, China needs to address the trilemma of international finance, including relaxing regulations on capital movements.
Keywords: Internationalization of Renminbi, Renminbi international settlement systems, digital Yuan
JEL Classification: F3, G1, N2
| By FUKUDA Shin-ichi | (Professor, Graduate School of Economics, The University of Tokyo, and Professor, Research Center for Advanced Science and Technology, The University of Tokyo) |
The potential growth rates of emerging economies are much larger than those of developed economies. However, many emerging economies have vulnerable economic fundamentals and have frequently experienced severe economic crises in the past. As a result, making their local currencies credible and realizing sustainable growth have been significant priorities for many emerging economies. This paper analyzes what impacts the choice of exchange rate regimes had on macroeconomic performance of emerging economies using the panel data from the second half of the 2000s. In the analysis, we focus not only on the effects of traditional exchange rate regimes such as the floating and fixed exchange rate regimes, but also on those of the inflation targeting and anchored exchange rate regimes. We explore their effects on the three macroeconomic performance indicators: economic growth rates, exchange rate depreciation rates, and inflation rates. The analysis revealed that the fixed exchange rate and anchored exchange rate regimes mitigated the exchange rate depreciation and the inflation rate acceleration, but decreased economic growth in emerging economies. On the other hand, the inflation targeting regime not only sustained economic growth as the floating exchange rate regime did, but also mitigated the exchange rate depreciation and the inflation rate acceleration as the fixed exchange rate regime did. This result shows that emerging economies adopting the inflation targeting could achieve high economic growth by maintaining flexibility in monetary policy as countries with floating exchange rates did. At the same time, they could also achieve a stable inflation rate than countries with floating exchange rates. However, if we were to look at the short-run effects of introducing the inflation targeting, the results suggested that although the inflation targeting was effective in promoting growth, it was not effective in controlling inflation rates. Additionally, while the inflation targeting regime could stabilize short-term volatility of growth rates to some extent, no significant effects were observed in stabilizing exchange rate and inflation rate volatilities.
Keywords: Emerging economies, monetary systems, inflation targeting
JEL Classification: F30, F31, F33, E42
| By ARIYOSHI Akira | (Specially Appointed Professor, Graduate School of International Relations, International University of Japan) |
Although the International Monetary Fund (IMF) played a central role in the international monetary system in the post-World War II Bretton Woods system, it has been forced to adapt to changes in the environment, including in particular the transition to a multi-currency system and a globalized financial system. With the role of the IMF in the international monetary system becoming more limited, to that of providing emergency assistance, the Fund is branching outside its traditional focus on macroeconomic and exchange rate policies, including into that of an aid agency. The main tools with which the IMF now exercises its influence are its analysis and recommendations, but for these to be effective, it needs to have adequate expertise as well as broad trust and support. In this regard, the financial system presents an important source of risk to the international monetary system, but it is not evident that the IMF has sufficient expertise in this area. Moreover, the international political situation is casting shadows over efforts to gain widespread support for the IMF. When looking ahead to the future of the international monetary system, there are risks of fragmentation brought about by factors such as financial technology and international politics. The IMF faces significant challenges as a global institution in maintaining its role as a forum for collaboration in the international monetary system, not least through exercising intellectual leadership and enhancing solidarity.
Keywords: International Monetary Fund (IMF), international monetary system, international institutions, international cooperation
JEL Classification: F33, F53, F55
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