Bretton Woods System: Fixed Exchange Rates and IMF Role

Bretton Woods System: Fixed Exchange Rates and the IMF

The Bretton Woods system featured fixed exchange rates, although adjustments to parities were possible under extraordinary circumstances. Unlike the gold standard, only the U.S. dollar was legally bound to gold and convertible at a fixed value. This convertibility made the dollar highly desirable.

Other countries could acquire dollars in the international market and use them as a guarantee to issue their own currency. This system allowed for the potential to issue more currency with the same amount of gold reserves, benefiting from the U.S.'s unique position. This was advantageous under Keynesian policies.

However, the system was asymmetric, granting the U.S. significant power due to its ability to print dollars. While it functioned well in the short term, it proved unstable in the long run. Only the dollar was directly linked to gold, while other currencies were linked to the dollar.

IMF's Role in Financing Deficits

The IMF could finance temporary foreign deficits (current accounts + foreign direct investment). Keynes emphasized prioritizing internal equilibrium (fighting unemployment) over foreign equilibrium. He believed domestic economic stability should take precedence.

Foreign deficits arise when a country's exports are insufficient. These can be balanced by current account balances or foreign investment. Under the gold standard, deficits led to gold losses. However, the Bretton Woods system allowed the IMF to offer loans to balance deficits through countercyclical policies, stimulating aggregate demand.

The IMF's policies were designed as short-term solutions. For structural issues, parity changes were necessary, but the IMF couldn't directly assist. Devaluation required agreement among the IMF board members.

The effectiveness of these policies depended on the IMF's available funds, largely contributed by the U.S. As contributions dwindled, so did the IMF's influence. Voting power on the board was proportional to each country's investment.

Capital Flow Controls

The Bretton Woods system implemented capital flow controls to regulate international capital movements. Without these controls, capital would flow to countries with lower interest rates.

Under the gold standard, countries' monetary policies were constrained by their gold reserves.

The gold standard system inherently creates fixed exchange rates. If two currencies are fixed to a specific amount of gold, their value relative to each other remains constant.

Keynesian Influence After WWII

Following World War II, Keynesian ideas gained prominence. Governments adopted countercyclical, internal policies to achieve growth and employment goals.