International Finance

This essay written for The New Palgrave dictionary of Ecnomics provides a selective and interpretive account of the development of thought on international financial questions. Attention is focused on the process of international adjustment and on the proper definition of external balance. Since the first descriptions of the price-specie-flow mechanism in Humes time, the definition of external balance has evolved in response to changes in the world economy's structure. The foreign reserve constraint so central under the gold standard or in the early Bretton Woods years is less important under conditions of high international capital mobility. Increasingly, the current account and the national intertemporal budget constraint are emphasized in discussions of international adjustment. In analogy with the idea of a high-employment government budget surplus, a working definition of external balance might be a current account that maintains the highest possible steady consumption level consistent with the economy's expected intertemporal budget constraint. Intertemporal approaches to external balance become more difficult to apply when countries face credit rationing as a result of nonrepayment risk.