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The Adjustment Mechanism

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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, 1945 to 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 with the growing efficiency of the international capital market, however. 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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3943.

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Date of creation: Dec 1991
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Publication status: published as A Retrospective on the Bretton Woods System, edited by Michael D. Bordo and Barry Eichengreen, pp. 201-268. Chicago, IL: University of Chicago Press, 1993.
Handle: RePEc:nbr:nberwo:3943

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  1. 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, Elsevier, vol. 1(1), pages 141-152, January.
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Cited by:
  1. Bernard Eschweiler & Michael D. Bordo, 1996. "Rules, Discretion, and Central Bank Independence: The German Experience 1880 - 1989," Departmental Working Papers, Rutgers University, Department of Economics 199402, Rutgers University, Department of Economics.
  2. Maurice Obstfeld, 2007. "The Renminbifs Dollar Peg at the Crossroads," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, Institute for Monetary and Economic Studies, Bank of Japan, vol. 25(S1), pages 29-56, December.
  3. Hans Joachim Voth, 2001. "Convertibility, currency controls and the cost of capital in Western Europe, 1950-1999," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 552, Department of Economics and Business, Universitat Pompeu Fabra.
  4. 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.
  5. Klug, Adam & Smith, Gregor W., 1999. "Suez and Sterling, 1956," Explorations in Economic History, Elsevier, Elsevier, vol. 36(3), pages 181-203, July.
  6. Helge Berger & Ulrich Woitek, . "Does Conservatism Matter? A Time Series Approach to Central Banking," Working Papers, Business School - Economics, University of Glasgow 9814, Business School - Economics, University of Glasgow, revised May 1999.
  7. Michael D. Bordo, 2005. "Historical Perspective on Global Imbalances," NBER Working Papers 11383, National Bureau of Economic Research, Inc.
  8. 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.
  9. Berger, Helge & Woitek, Ulrich, 2001. "The German political business cycle: money demand rather than monetary policy," European Journal of Political Economy, Elsevier, Elsevier, vol. 17(3), pages 609-631, September.

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