Glossary

More detailed Glossary

WHAT IS A COUNTRY'S BALANCE OF PAYMENTS?
A balance of payments is achieved when the amount of money leaving a country to purchase imports of goods and services and to invest in other countries equals the amount of money entering the country through the sale of exports and the inflow of investments. Deficits (shortfalls) or surpluses in the balance of payments can be brought into balance by increased trade and investment or by moving currency reserves between countries.

WHAT IS A COUNTRY'S BALANCE OF TRADE?
A balance of trade is the difference between the value of goods imported and the value of goods exported. A favorable balance of trade implies an excess in the value of exports over imports. An unfavorable balance of trade implies the reverse.

WHAT IS THE BRETTON WOODS SYSTEM?
The Bretton Woods System, conceived at Bretton Woods, New Hampshire in 1944, was implemented by the International Monetary Fund until the 1970s. This system provided for fixed exchange rates (based on the U.S. dollar pegged to gold) and aimed for the unrestricted conversion of one currency for another in settling current payments between member countries. Its purpose was to increase employment, assist trade, and encourage international prosperity. The system, abandoned in the 1970s when the U.S. government was no longer able to exchange gold for dollars at $35.00 an ounce, has been replaced by the present regime of surveillance by the IMF over member countries' exchange policies.

WHAT IS CAPITAL?
Capital consists of man-made assets, either physical (e.g., machines) or financial (e.g., investments), that are capable of generating income.

WHAT IS THE CAPITAL ACCOUNT?
The capital account measures all international capital transfers (i.e., long- and short-term loans and grants that private individuals and governments make to or receive from foreign private individuals or foreign governments). Capital-account assets represent a country's investments abroad; liabilities the investment of foreigners in the country.

WHAT IS A CENTRAL BANK?
Central banks are institutions responsible for monitoring economic data, overseeing banking, accounting for monetary and gold reserves, and adjusting the money supply in order to keep the economy on course. In the United States, the Federal Reserve System performs these functions. Their charters usually make central banks independent of government so as to avoid unhelpful political influence.

WHAT ARE CENTRALLY PLANNED ECONOMIES?
In centrally planned economies, the state, rather than the free market, determines where investments will be made, what will be produced, what the level of wages and salaries will be, and how much products will cost. Centrally planned economies are inspired by a socialist, nonmarket philosophy.

WHAT IS CONVERTIBLE CURRENCY?
Convertible currency is currency that is accepted in exchange for another currency. A country with external convertibility allows nonresidents to exchange its currency for other currencies. A fundamental goal of the IMF is universal currency convertibility.

WHAT IS CURRENCY?
Currency consists of notes and coins used as a medium of exchange.

WHAT IS THE CURRENT ACCOUNT?
The current account comprises the entries in the balance of payments account that summarize exports and imports of goods and services by individuals and governments.

WHAT IS DEFICIT FINANCING?
Deficit financing occurs when a government spends more money than it can raise by taxation or other means. John Maynard Keynes advocated this policy during the Great Depression to increase employment and thereby inject purchasing power into the sluggish economy

WHAT IS DEPRECIATION?
Depreciation is the reduction in the value of a currency in terms of other currencies under market conditions because of a decline in demand for that currency in relation to its supply.

WHAT IS DEVALUATION?
Devaluation is the attempt by a government to reduce its currency's value in terms of other currencies. Governments lower the value of their currency relative to other currencies in order to make their country's products more competitive on world markets and boost exports. Devaluation also makes imports less affordable and protects local industry against foreign competition. During the Great Depression of the 1930s, many countries devalued their currencies to help boost their economies at other countries' expense, a practice known as beggaring thy neighbor. Unfortunately, this lowered overall demand for imports and retarded a general recovery. The IMF was founded partially in response to this unfortunate practice.

WHAT IS A DEVELOPING COUNTRY?
Developing countries are partially industrialized countries that usually lack sufficient national income or domestic private capital to finance the investment required to reach modern industrial statehood. In the early stages of development these countries usually look to multilateral lending institutions for finance. As they become more economically self-sufficient they are able to tap the international capital markets for loans or finance further development.

WHAT IS ECONOMICS?
Economics is the study of the best way to allocate scarce resources to produce and distribute goods and services throughout society.

WHAT IS AN EMBARGO?
An embargo legally prohibits some or all trade with a foreign country. Governments resort to embargo to express displeasure with the policies of another country and to attempt to coerce the country to change its policies.

WHAT IS EXCESS LIQUIDITY?
Excess liquidity is the unusual condition of countries' having too much money. (Private individuals seldom experience this condition). In the late 1970s, the rise in oil prices brought in a flood of money (more than could be immediately spent) into the oil-producing countries. Prudently, these countries placed much of this excess money in banks, which soon found themselves in the unusual position of having excess liquidity: more money than they could conveniently lend.

WHAT IS FISCAL POLICY?
Fiscal Policy refers to the package of policy initiates used by a government to achieve a satisfactory level of revenues and expenditures.

WHAT IS A FIXED DOLLAR-GOLD EXHANGE RATE?
The dollar-gold exchange rate ($35.00 = one ounce of gold) was established at the Bretton Woods conference in 1944. The value of other world currencies was expressed in dollars, and therefore by implication was also pegged to gold. Under the Bretton Woods system, any-one could redeem dollars for gold from the U.S. Treasury at the rate of $35.00 per ounce. When inflation began to erode confidence in the value of the dollar, the rush to redeem dollars for gold threatened to wipe out the U. S. gold reserves.

WHAT ARE FISCAL OR BUDGET DEFICITS?
Fiscal or budget deficits occur when governments expenditures exceed revenues. The way out of a budget deficit may involve raising taxes, reducing government expenditure, or a combination of both. Obviously none of these solutions is popular with the electorate. For this reason, politicians are often loath to make the hard decisions required, the budget deficit worsens, and, in some cases, the government must seek assistance from international lenders.

WHAT ARE FIXED EXCHANGE RATES?
Fixed exchange rates are a system in which the exchange value of a currency is kept stable by tying the value of that currency to the value of another currency or basket of currencies (such as five pesos to a dollar). Maintaining a fixed exchange rate requires (a) that a country hold sufficient foreign exchange reserves to intervene in the market to reduce variations in the value of its currency and (b) that it implement fiscal and monetary policies that keep these variations small.

WHAT ARE FLEXIBLE EXCHANGE RATES?
Flexible exchange rates are a system in which the exchange value of a currency is allowed to seek its own level in response to market forces. The government issuing the currency engages in little or no market intervention to stabilize the exchange rate.

WHAT IS A FREE MARKET SYSTEM?
In a free market system, private investors, rather than the state, determine where investments will be made, what will be produced, what the level of wages and salaries will be, and how much products will cost. The free-market system is inspired by a capitalist philosophy.

WHAT IS FOREIGN INVESTMENT?
Foreign investment is the acquisition of assets in one country by government, institutions, or individuals in another country. Foreign investment can be indirect (buying shares of existing enterprises in other countries) or direct (setting up subsidiaries and new enterprises in other countries).

WHAT IS THE GDP?
The GDP is the gross domestic product: the value of all goods and services produced in a country during one year. The GDP per capita is the gross domestic product divided by the number of people in that country.

WHAT IS GLOBALIZATION?
Globalization is the integration of the financing, production, and marketing of goods and services across national boundaries.

WHAT ARE GOLD RESERVES?
Gold reserves are the gold bullion stocked by a country's central bank. Under the gold standard, paper currencies could be exchanged for gold on demand. Although the gold standard has been abandoned, many central banks still stock gold bullion.

WHAT ARE HARD AND SOFT CURRENCIES?
Hard currency is a currency widely accepted in foreign trade. Soft currency is a currency whose value is uncertain and which is therefore not widely accepted in foreign trade. When developing countries gained their independence from the European colonial powers, they instituted their own official "soft" currencies. With few reserves of hard currencies, the newly independent countries found it difficult to import goods and services to spur economic growth.

WHAT IS AN IMF ADJUSTMENT PROGRAM?
An IMF adjustment program is a package of policy measures, agreed on between the IMF and a member country, designed to alleviate the member country's balance of payments problems.

WHAT WERE THE IMF'S OIL FACILITIES?
The two IMF Oil Facilities were Fund initiatives to channel borrowed money at below-market rates of interest to developing countries hardest hit by the rise in oil prices that began in 1973. They were temporary measures; eventually all countries have had to adjust to permanently higher (though fluctuating) oil prices.

WHAT IS IMF SURVEILLANCE?
IMF Surveillance involves an ongoing examination by the Fund of the economic, monetary, fiscal, and exchange policies of member countries, carried out with the cooperation of those countries. One result of this examination is an economic report on each country, which is discussed in the IMF's Executive Board and disclosed to the entire membership. Surveillance thus ensures the openness of each member's policies and intentions and assists all member countries in their economic dealings with one another.

WHAT IS INFLATION?
Inflation is the pursuit of too few goods by too much money. Normally, when governments see signs of inflation, they try to reduce the amount of money in circulation by raising interest rates. After World War II, rebuilding European industry in order to make more consumer goods available was seen as a necessary remedy for inflation.

WHAT ARE INTEREST RATES?
Interest rates are the cost of borrowing money. When a central bank (the institution in each country which adjusts the money supply and accounts for monetary and gold reserves) decides to change the interest rate on money it lends to banks, the banks respond with a corresponding change in the interest rate on money they lend to businesses and private individuals. Central banks raise short-term interest rates to discourage borrowing, slow economic growth, and hold inflation in check. They lower short-term interest rates to spur economic growth by encouraging business investment and consumer spending.

WHAT IS INTERNATIONAL CAPITAL?
International capital refers to assets that move from one country to another. In theory, international capital flows are economically efficient since investors tend to place their money only in viable enterprises where there is good reason to expect profit.

WHAT IS MONEY?
Money is any object widely accepted in payment for goods and services and in settling debts. Although in the past money has assumed many exotic forms (sticks, shells, beads), today it is primarily bills and coins. Money is not only a medium of exchange accepted in payment for goods and services, but also serves as a unit of account, in terms of which the price of every-thing else is stated, and as a store of value, which assists holders of money to conserve wealth.

WHAT IS MONETARY POLICY?
Monetary Policy is the package of policy initiatives adopted by the government to achieve a satisfactory supply of money, level of interest rates, and exchange rate for its currency.

WHAT IS A MONETARY RESERVE?
Monetary reserves are currencies held by a government usually in its central bank, in addition to its gold reserves. A shortage of gold in the 1960s led many governments to supplement their gold reserves with monetary reserves. Governments began to hoard U.S. dollars and British pounds which were accepted widely in trade and perceived to be stable in value.

WHAT IS A MONEY SHORTAGE?
Money shortage refers to a lack of currency acceptable as payment in world trade. During World War II, the European countries had sold off most of their gold reserves to finance the war. Since their economies were in ruin and their currencies of little value, they were said to be suffering a money shortage. After World War II, the United States held most of the world's money in the form of dollars and gold.

WHAT IS MULTILATERAL TRADE?
Multilateral trade refers to the exchange of goods and services among many countries. During the Great Depression it often happened that a country tried to protect itself from out-side competition by forming a trade alliance with another country (bilateralism) or with a group of countries (regional trading blocs). These alliances extended favorable trading conditions (low tariffs and high quotas) to their members, and thus erected trade barriers to countries outside the alliance.

WHAT ARE REAL PRICES?
Real prices are prices that have been adjusted for inflation. Separating the inflationary correspondent from the price often gives a more accurate and informative insight into the price trend over time.

WHAT IS A RESCHEDULING OF DEBT?
A country, finding itself able to pay its debt on time, can often negotiate with the lender a rescheduling of debt—allowing it a longer period in which to repay what it owes. Rescheduling is beneficial to both borrower and lender. The borrowing country avoids default (which can have drastic consequences for its credit rating) and, although it might have to pay more in interest charges, is not forced to take other, more damaging measures. The lender, considering the alternative of getting nothing back in the event of default, is generally happy to agree to a rescheduling.

WHAT IS AN SDR?
The SDR (Special Drawing Right) is a reserve asset created and distributed by the International Monetary Fund to supplement the reserves of its member countries. SDRs were first created in 1969 to free other reserve assets (convertible currencies and gold) for use in foreign trade and other international transactions. SDRs cannot be used in payment by private individuals. They exist only as electronic accounting balances and are either retained as reserves or exchanged to settle payments between the IMF and its members or between member countries themselves.

WHAT IS A SHORTAGE OF LIQUIDITY?
A shortage of liquidity refers to a condition in which the supply of hard currency or other assets is insufficient to meet the demands of world trade. During the 1960s, many feared that the United States would cut back on its imports to correct its burgeoning balance of payments deficit. If it did so, the diminished stream of dollars flowing abroad would result in an international liquidity shortage.

WHAT ARE TRADE BARRIERS?
Trade barriers are attempts to limit the import of foreign goods and services into a country. The most common barriers are quotas (limiting the quantity of foreign goods that can enter the country), tariffs (charging a tax on goods entering the country), and subsidies (paying local producers to lower the price of their goods relative to foreign competitors).

WHAT ARE TRADE DEFICITS?
Trade deficits occur when a country is spending more on imports than it receives from exports. As industries in Europe and Japan recovered from World War II, the United States began to develop balance of trade deficits with these countries since the value of goods bought from them exceeded the value of U.S. goods sold to them.

WHAT ARE THE TRANSITION ECONOMIES?
Transition economies are economies moving from central planning to a free-market system. Specifically, the term refers to Russia and other member countries of the former Soviet Union, as well as to the formerly nonmarket countries of Eastern and Central Europe.

Back to All About Money Curriculum Table of Contents