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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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  • Maurice Obstfeld, 1993. "The Adjustment Mechanism," NBER Chapters, in: A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform, pages 201-268, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberch:6871
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    Cited by:

    1. Barry Eichengreen., 1994. "History and Reform of the International Monetary System," Center for International and Development Economics Research (CIDER) Working Papers C94-041, University of California at Berkeley.
    2. Terborgh, Andrew G., 2003. "The post-war rise of world trade: does the Bretton Woods System deserve credit?," Economic History Working Papers 22351, London School of Economics and Political Science, Department of Economic History.
    3. Michael Bordo & Barry Eichengreen, 2013. "Bretton Woods and the Great Inflation," NBER Chapters, in: The Great Inflation: The Rebirth of Modern Central Banking, pages 449-489, National Bureau of Economic Research, Inc.
    4. Maurice Obstfeld, 2007. "The Renminbi's Dollar Peg at the Crossroads," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 25(S1), pages 29-56, December.
    5. 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.
    6. Maurice Obstfeld., 2001. "International Macroeconomics: Beyond the Mundell-Fleming Model," Center for International and Development Economics Research (CIDER) Working Papers C01-121, University of California at Berkeley.
    7. Barry Eichengreen., 1993. "Prerequisites for International Monetary Stability," Center for International and Development Economics Research (CIDER) Working Papers C93-018, University of California at Berkeley.
    8. Helge Berger & Ulrich Woitek, "undated". "Does Conservatism Matter? A Time Series Approach to Central Banking," Working Papers 9814, Business School - Economics, University of Glasgow, revised May 1999.
    9. Klug, Adam & Smith, Gregor W., 1999. "Suez and Sterling, 1956," Explorations in Economic History, Elsevier, vol. 36(3), pages 181-203, July.
    10. Charles W. Calomiris & Christopher Hanes, 1994. "Historical Macroeconomics and American Macroeconomic History," NBER Working Papers 4935, National Bureau of Economic Research, Inc.
    11. Eichengreen, Barry, 1994. "The Bretton Woods System: Paradise Lost?," Center for International and Development Economics Research (CIDER) Working Papers 233394, University of California-Berkeley, Department of Economics.
    12. Michael D. Bordo, 2005. "Historical Perspective on Global Imbalances," NBER Working Papers 11383, National Bureau of Economic Research, Inc.
    13. 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.
    14. Daniel Kaufmann, 2019. "Nominal stability over two centuries," Swiss Journal of Economics and Statistics, Springer;Swiss Society of Economics and Statistics, vol. 155(1), pages 1-23, December.
    15. 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.
    16. Kevin Gallagher, 2011. "Regaining Control? Capital Controls and the Global Financial Crisis," Working Papers wp250, Political Economy Research Institute, University of Massachusetts at Amherst.
    17. M. Kabir Hassan & Ashraf Nakibullah, 2008. "Gulf Monetary Union and Regional Integration," Working Papers 453, Economic Research Forum, revised 09 Jan 2008.
    18. Bernhard Eschweiler & Michael D. Bordo, 1993. "Rules, Discretion, and Central Bank Independence: The German Experience 1880-1989," NBER Working Papers 4547, National Bureau of Economic Research, Inc.
    19. 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.
    20. Chen, Yao & Ward, Felix, 2019. "When do fixed exchange rates work? Evidence from the Gold Standard," Journal of International Economics, Elsevier, vol. 116(C), pages 158-172.
    21. Kevin Gallagher, 2012. "The Global Governance of Capital Flows: New Opportunities, Enduring Challenges," Working Papers wp283, Political Economy Research Institute, University of Massachusetts at Amherst.
    22. Nicholas Crafts, 2021. "What can we learn from the United Kingdom’s post‐1945 economic reforms?," Economic Affairs, Wiley Blackwell, vol. 41(3), pages 354-376, October.
    23. Pasula, Kit, 1997. "Monetary Non-Neutrality and the Intertemporal Approach to the Balance of Trade: The UK Trade Balance under Bretton Woods," Review of International Economics, Wiley Blackwell, vol. 5(3), pages 333-347, August.

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