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Kydland, Charles Wyplosz, Wyplosz, Charles, Devereux, Michael B. Politecnica Marche - Dept. Economic and Social Sciences. Gray, You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp See general information about how to correct material in RePEc. For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact:.
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Specialists in international relations have argued that international regimes operate smoothly and exhibit stability only when dominated by a single, exceptionally powerful national economy. In particular, this "theory of hegemonic stability" has been applied to the international monetary system. The maintenance of the Bretton Woods System for a quarter of a century up to is ascribed to the singular power of the United States in the postwar world, while the persistence of the classical gold standard is similarly ascribed to Britain's dominance of 19th-century financial markets.
In contrast, the instability of the interwar gold-exchange standard is attributed to the absence of a hegemonic power. Attaining this balance can be very difficult. Changes in the geographic distribution of economic and political power, the global integration of goods and asset markets, wars, and inconsistent monetary and fiscal policies all have the potential to undermine a monetary system. Past systems could not incent systemic countries to adjust policies in a timely manner.
There are reasons for concern. Ruggie, John Gerard, All this implies that one possible scenario is the evolution towards a truly multi-polar IMS , which, as many have recently observed, would produce credible alternatives to dollar-denominated investments, thereby enhancing policy discipline in the core reserve issuer. Until the s, most monetary systems were based on a bimetallic standard. Others contend that Bretton Woods was a consequence rather than a cause of the post-war growth and suffered from a number of structural weaknesses that sealed its fate from the outset. Yongzheng Yang.
The question is whether the current shock of integrating one-third of humanity into the global economy — positive as it is — will overwhelm the adjustment mechanisms of the current system. There are reasons for concern. China's integration into the global economy alone represents a much bigger shock to the system than the emergence of the United States at the turn of the last century. China's share of global GDP has increased faster and its economy is much more open.
History shows that systems dominated by fixed or pegged exchange rates seldom cope well with major structural shocks. This failure is the result of two pervasive problems: an asymmetric adjustment process and the downward rigidity of nominal prices and wages. In the short run, it is generally much less costly, economically as well as politically, for countries with a balance of payments surplus to run persistent surpluses and accumulate reserves than it is for deficit countries to sustain deficits. This is because the only limit on reserve accumulation is its ultimate impact on domestic prices.
Depending on the openness of the financial system and the degree of sterilization, this can be delayed for a very long time. Flexible exchange rates prevent many of these problems by providing less costly and more symmetric adjustment. Relative wages and prices can adjust quickly to shocks through nominal exchange rate movements in order to restore external balance.
When the exchange rate floats and there is a liquid foreign exchange market, reserve holdings are seldom required. A brief review of how the different international monetary regimes failed to manage this trade-off between nominal stability and timely adjustment provides important insights for current challenges. Under the classical gold standard, from to , the international monetary system was largely decentralized and market-based.
There was minimal institutional support, apart from the joint commitment of the major economies to maintain the gold price of their currencies. Although the adjustment to external imbalances should, in theory, have been relatively smooth, in practice it was not problem-free. Deficit countries found the adjustment even more difficult because of downward wage and price stickiness. Once the shocks were large and persistent enough, the consequences of forfeiting monetary independence and asymmetric adjustment ultimately undermined the system. The gold standard did not survive World War I intact.
Widespread inflation caused by money-financed war expenditures and major shifts in the composition of global economic power undermined the pre-war gold parities. Crucially, there was no mechanism to coordinate an orderly return to inflation-adjusted exchange rates. When countries, such as the United Kingdom in , tried to return to the gold standard at overvalued parities, they were forced to endure painful deflation of wages and prices in order to restore competitiveness.
Though this was always going to be difficult, it proved impossible when surplus countries thwarted reflation.
During the Great Depression, with an open capital account and a commitment to the gold-exchange standard, the United States could not use monetary policy to offset the economic contraction. Unable to adjust to these pressures, countries were forced to abandon the system. Though deficit countries experienced the first crisis, all countries suffered from the eventual collapse — a lesson that was repeated in subsequent systems.
The Bretton Woods system of pegged, but adjustable, exchange rates was a direct response to the instability of the interwar period. Bretton Woods was very different from the gold standard: it was more administered than market-based; adjustment was coordinated through the International Monetary Fund IMF ; there were rules rather than conventions; 7 and capital controls were widespread.
Despite these institutional changes, surplus countries still resisted adjustment. Foreshadowing present problems, countries often sterilized the impact of surpluses on domestic money supply and prices. Like today, these interventions were justified by arguing that imbalances were temporary and that, in any event, surpluses were evidence more of virtue than "disequilibria. The Bretton Woods system finally collapsed in the early s after U.
Once again, all countries suffered from the aftershocks. After the breakdown of the Bretton Woods system, the international monetary system reverted to a more decentralized, market-based model. Major countries floated their exchange rates, made their currencies convertible, and gradually liberalized capital flows. In recent years, several major emerging markets adopted similar policies after experiencing the difficulties of managing pegged exchange rate regimes with increasingly open capital accounts. The move to more market-determined exchange rates has increased control of domestic monetary policy and inflation, accelerated the development of financial sectors, and, ultimately, boosted economic growth.
Unfortunately, this trend has been far from universal. In many respects, the recent crisis represents a classic example of asymmetric adjustment. Some major economies have frustrated real exchange rate adjustments by accumulating enormous foreign reserves and sterilizing the inflows.
While their initial objective was to self-insure against future crises, reserve accumulation soon outstripped these requirements Table 1. In some cases, persistent exchange rate intervention has served primarily to maintain undervalued exchange rates and promote export-led growth. This flip side of these imbalances was a large current account deficit in the United States, which was reinforced by expansionary U.
In combination with high savings rates in East Asia, these policies generated large global imbalances and massive capital flows, creating the "conundrum" of very low long-term interest rates, which, in turn, fed the search for yield and excessive leverage. While concerns over global imbalances were frequently expressed in the run-up to the crisis, the international monetary system once again failed to promote the actions needed to address the problem. Vulnerabilities simply grew until the breaking point. Some pressures remain. The financial crisis could have long-lasting effects on the composition and rate of global economic growth.
However, those countries with relatively fixed exchange rates and relatively open capital accounts are acting as if it is. If this divergence in optimal monetary policy stance increases, the strains on the system will grow. Postponed adjustment will only serve to increase vulnerabilities. In the past, the frustration of adjustment by surplus countries generated deflationary pressures on the rest of the world.
Similarly, today, the adjustment burden is being shifted to others. Advanced countries — including Canada, Japan, and the Euro area — have recently seen sizable appreciations of their currencies. The net result could be a suboptimal global recovery, in which the adjustment burden in those countries with large imbalances falls largely on domestic prices and wages rather than on nominal exchange rates.