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The Adjustment Mechanism

In: A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform

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  • Maurice Obstfeld

Abstract

This paper studies the mechanisms of international payments adjustment at work under the Bretton Woods system of fixed exchange rates between 1945 and 1971. I argue that two market failures - imperfect international capital mobility and imperfect wage-price flexibility - are central to understanding the adjustment problems of that period. Imperfect capital mobility implied that even intertemporally solvent governments could face international liquidity constraints. Wage-price inflexibility implied that countries suffering from simultaneous reserve loss and unemployment might need to undergo lengthy transitions before returning to balance. By the 1960s, when trade had been substantially liberalized and partial convertibility restored, the main remaining adjustment weapon was currency realignment: devaluation could eliminate an unemployment-cum-deficit dilemma in a stroke, while revaluation could relieve the inflationary pressures in surplus countries. The currency realignment option proved incompatible, however, with the growing efficiency of the international capital market. Under the classical gold standard, high capital mobility had supported the credibility of fixed exchange rates. Under Bretton Woods, fixed gold parities did not have primacy among other economic objectives; and increasing capital mobility undermined the regime as governments proved unwilling to stand by key systemic commitments.

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This chapter was published in:

  • Michael D. Bordo & Barry Eichengreen, 1993. "A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform," NBER Books, National Bureau of Economic Research, Inc, number bord93-1, octubre-d.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 6871.

    Handle: RePEc:nbr:nberch:6871

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    1. Eichengreen, Barry, 1989. "The Gold Standard Since Alec Ford," Department of Economics, Working Paper Series qt91z49066, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    2. Obstfeld, Maurice, 1980. "Imperfect asset substitutability and monetary policy under fixed exchange rates," Journal of International Economics, Elsevier, vol. 10(2), pages 177-200, May.
    3. Aliber, Robert Z, 1973. "The Interest Rate Parity Theorem: A Reinterpretation," Journal of Political Economy, University of Chicago Press, vol. 81(6), pages 1451-59, Nov.-Dec..
    4. Michael D. Bordo & Finn E. Kydland, 1992. "The gold standard as a rule," Working Paper 9205, Federal Reserve Bank of Cleveland.
    5. Persson, Torsten, 1984. "Real transfers in fixed exchange rate systems and the international adjustment mechanism," Journal of Monetary Economics, Elsevier, vol. 13(3), pages 349-369, May.
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    8. Grilli, Vittorio, 1990. "Managing exchange rate crises: evidence from the 1890s," Journal of International Money and Finance, Elsevier, vol. 9(3), pages 258-275, September.
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    11. Alogoskoufis, George S & Smith, Ron, 1991. "The Phillips Curve, the Persistence of Inflation, and the Lucas Critique: Evidence from Exchange-Rate Regimes," American Economic Review, American Economic Association, vol. 81(5), pages 1254-75, December.
    12. Laney, Leroy O. & Willett, Thomas D., 1982. "The international liquidity explosion and worldwide inflation: The evidence from sterilization coefficient estimates," Journal of International Money and Finance, Elsevier, vol. 1(1), pages 141-152, January.
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    15. Michael R. Darby & James R. Lothian & Arthur E. Gandolfi & Anna J. Schwartz & Alan C. Stockman, 1983. "The International Transmission of Inflation," NBER Books, National Bureau of Economic Research, Inc, number darb83-1, octubre-d.
    16. Miles, Marc A, 1979. "The Effects of Devaluation on the Trade Balance and the Balance of Payments: Some New Results," Journal of Political Economy, University of Chicago Press, vol. 87(3), pages 600-20, June.
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    Cited by:
    1. Maurice Obstfeld, 2007. "The Renminbifs Dollar Peg at the Crossroads," IMES Discussion Paper Series 07-E-11, Institute for Monetary and Economic Studies, Bank of Japan.
    2. Klug, Adam & Smith, Gregor W., 1999. "Suez and Sterling, 1956," Explorations in Economic History, Elsevier, vol. 36(3), pages 181-203, July.
    3. Maurice Obstfeld & Alan M. Taylor, 1998. "The Great Depression as a Watershed: International Capital Mobility over the Long Run," NBER Chapters, in: The Defining Moment: The Great Depression and the American Economy in the Twentieth Century, pages 353-402 National Bureau of Economic Research, Inc.
    4. Bernard Eschweiler & Michael D. Bordo, 1996. "Rules, Discretion, and Central Bank Independence: The German Experience 1880 - 1989," Departmental Working Papers 199402, Rutgers University, Department of Economics.
    5. Hans-Joachim Voth, 2003. "Convertibility, currency controls and the cost of capital in Western Europe, 1950-1999," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 8(3), pages 255-276.
    6. Berger, Helge & Woitek, Ulrich, 2001. "The German political business cycle: money demand rather than monetary policy," European Journal of Political Economy, Elsevier, vol. 17(3), pages 609-631, September.
    7. Michael D. Bordo, 2005. "Historical Perspective on Global Imbalances," NBER Working Papers 11383, National Bureau of Economic Research, Inc.
    8. Helge Berger & Ulrich Woitek, 1999. "Does Conservatism Matter? A Time Series Approach to Central Banking," CESifo Working Paper Series 190, CESifo Group Munich.
    9. Michael D. Bordo & Barry Eichengreen, 1998. "The Rise and Fall of a Barbarous Relic: The Role of Gold in the International Monetary SYstem," NBER Working Papers 6436, National Bureau of Economic Research, Inc.

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