The Most Important Elements of International Monetary Regime - Essay Example

International Monetary Regime International Monetary Regime Introduction This paper aims to discuss the most important elements of International Monetary Regime which is also referred as Bretton Woods System. This monetary regime was developed in the early years after World War II and it continued to prevail till 1970s. It has a close connection with the conference in which the International Monetary Fund (IMF) and the Word Bank were established. Moreover, it represented the very first example of a completely negotiated monetary system in the world’s history (Bretton Woods System, 2014). Its fundamental purpose was to protect the sovereign states and their currency relations. More specifically the International Monetary Regime was created to merge the multilateral decision making with the legal obligations. This process was supposed to conduct through the International Monetary Fund. Here it is important to notice that the initiation of International Monetary scheme, its development and termination were actually linked with the policies and preferences of USA (Bretton Woods System, 2014). In contrast to this John Maynard Keynes presented his plan in 1941 after observing the economic condition and deflation ever since the end of World War II. He believed that deflation was primarily caused by the unemployment issues identified in UK. Moreover, he regarded United States unbalanced creditor position as the primary deflationary pressure. The plan of Keynes was rejected by US because it was not ready to spend its savings on debtor countries. In 1944 the Bretton Woods Agreement was accepted and International Monetary Fund was established. This was based upon providing financial assistance on short term basis to countries which are facing difficulties in their balance of payments (Joshi, 2010). Discussion Monetary Policy The Bretton Woods Institution established a monetary system which actually combined the advantages of floating rates with the conventional gold standards. Here, gold standards represent the stability of exchange rate whereas floating rates refer to the independence for pursuing full employment policies on the national level. Moreover, this system wanted to eliminate the negative aspects of floating rates such as competitive devaluations and destabilizing assumptions in addition to the faults of the predetermined gold exchange rates (Bordo, 1991). This primarily includes the national monetary policies subordination in order of external balance and the economic weakness in the business cycles carried out in international transmission. As a result Bretton Woods formulated a peg system which was adjustable in nature (Bordo, 1991). Contrary to this, Keynes’s presented a monetary policy which was fundamentally composed of three important concepts. These include the marginal efficiency with respect to capital, investment multiplier and the interest rates. All three concepts are interrelated in the short term period to one another which helps in explaining Keynes opposition to monetary policy based on countercyclical approach (Dickens, 2011). Moreover, the interaction of marginal efficiency, investment multiplier and interest rates in the long term facilitates in understanding the long-period economic fluctuations. The latter concept is actually characterized by the idea of unemployment. According to Keynes the fundamental aim of a monetary authority is to influence the interest rates. This helps the economy in moving away from the equilibrium position in the long-period exemplified by the unemployment (Dickens, 2011). The monetary policy presented by Bretton Woods is significantly different from Keynes’s. For instance, Bretton Woods has more emphasis over the gold standards and the floating rates whereas Keynes emphasizes upon marginal efficiency, investment multiplier and interest rates. Furthermore, Bretton Woods focused on establishing the adjustable peg system while Keynes was more interested in achieving full employment economic state. Exchange rates Bretton Woods System explains exchange rates as fixed yet adjustable. The primary function of Bretton Woods was to avoid the unwarranted instability considered as the characterizing factor of floating exchange rates. They also wanted to avoid the competitive depreciations while allowing sufficient flexibility in order to regulate the fundamental disequilibrium in the global supervision. Moreover, the capital flow based on private concerns was expected to play very minimum role in the overall financing of imbalanced payments whereas extensive use of credit controls was predicted to avoid instability in these flows. In order to facilitate the adjustment process payment imbalances were officially financed on temporary basis primarily with the help of IMF (IMF Staff, 2000). Keynes was against the idea of fixed exchange rates in the era of 1920s. However, he was also opposing their generously fluctuation. Sometime later he developed another point of view according to which fixed exchange rates were only acceptable when they are regulated in the supervision of international rule. This suggests that in the early 1920s Keynes had significantly liberal views as compared to the interventionist which is evident by his opposition to trade restrictions. Later on he started favoring the exchange controls on the basis of permanent system (Meltzer, 1983). There is a very slight difference between the approaches of Bretton Woods and Keynes in case of exchange rate. For example, Bretton Woods explain exchange rates as fixed yet adjustable. On the other side Keynes strictly opposed fixed exchange rate while also disregarding their free fluctuation. International Credit The idea of international credit in terms of Bretton Woods is associated with the functions of International Monetary Fund. It was defined that the primary responsibility of IMF is to give credits to the member states provided that they have deficits in their balance of payments. However, there was a threat that the exchange rate of currency will deviate from the predetermined fixed rates on the basis of gold parity (Katasonov, 2014). When Bretton Woods Institution collapsed in 1970s then it was found unnecessary to encourage balance of payments through international credit provided by IMF. Hence the fund was proposed to be terminated. But IMF became an important tool for global financing and the economic liberation. Thus the basic concept of international credit was then transformed in to extending credit to replace social and political concessions from the loan obtaining countries. This actually relates to the idea of state property privatization and the state nonintervention in the matters of economy (Katasonov, 2014). Keynes had a distinctive idea about international credit. According to him countries facing significant trade deficit such that their deficit is more than the overdraft allowance of bancor then interest would be charged upon them. He also suggested reducing the currency values of these countries while preventing the capital export. However, he also argued that nations having trade surplus will face the similar pressures. This was due to the fact that nations which are having surplus in trade can actually help debtor countries through changing their policies. Hence he suggested that crediting countries should reinvest their surplus finances in the debtor nations’ economies (Monbiot, 2008). Bretton Woods’ concept of international credit was to support deficits in balance of payment. However, when in 1970’s Bretton Woods was collapsed then IMF started to influence the social and political concessions of the debtor countries through state property privatization. Keynes suggested that nations having trade surplus should reinvest their money in the economies of crediting nations. Policies for handling international payment imbalances and adjustment In order to comprehend the policies for handling international payment imbalances and adjustments it is important to first discuss White’s plan. White actually proposed a significant monetary institution with the name of Stabilization Fund which was supposed to be funded by a finite number of national currencies. It also included $5 million gold so as to limit the reserve credit supply (Establishment of the Bretton Woods System, 2013). Bretton Woods plan was somewhat similar to White’s plan with an addition of one clause. The clause stated that if a country has surplus balance of payments whereas it also faces scarcity in terms of currency in the world trade then the fund will be able to share that currency. Moreover, the fund could also approve partial imports from the surplus nation. The fund’s total resources were also raised in Bretton Woods System from $5 million to $8.5 million (Establishment of the Bretton Woods System, 2013). Keynes entitled the large institution’s creation which should have the authority and resources to intervene in any case of imbalance. This was related to his idea that public institutions must intervene when crises hit the nation. Keynes plan was based upon the Clearing Union which was supposed to act as a global central bank. Clearing Union would issue bancor, the new currency in order to resolve international imbalances. Keynes also suggested $26 million raising funds for the global central bank. Each country was supposed to have a limited credit which would protect it against deficit in balance of payments. However, countries were also discouraged to have excess bancor (Establishment of the Bretton Woods System, 2013). Bretton Woods plan for handling international payment imbalances and adjustments revolved around the idea of sharing the currency of nations having surplus balance of payment while also facing currency scarcity. Keynes plan suggests issuing new international currency called bancor so as to settle the payment imbalances. Conclusion The key elements of International Monetary Regime presented in the Bretton Woods Institution in the post World War II era are significantly different from Keynes’s Plan. The paper has discussed differences between the two economic policies while considering monetary system, exchange rates, international credit and the policies for handling international payment imbalances and adjustments. References Bordo, M. D. & Eichengreen, B. (1991). A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform. Chicago: University of Chicago Press. Bretton Woods System. (2014). Retrieved May 16, 2014, from University of California, Santa Barbara. Dickens, E. (2011). Keyness Theory of Monetary Policy: An Essay In Historical Reconstruction. Contributions to Political Economy , 1-11. Establishment of the Bretton Woods System. (2013). Retrieved May 16, 2014, from Federal Reserve History. Joshi, V. & Skidelsky, R. (2010). Keynes, Global Imbalances, and International Monetary Reform, Today. Rebalancing the Global Economy: A Primer for Policymaking by Stijn Claessens, Simon Evenett and Bernard Hoekman (eds) . Katasonov, V. (2014). Reform of the Bretton Woods Institutions: The IMF Might Not Live to See Its Anniversary. Retrieved May 16, 2014, from Centre for Research on Globalization. Meltzer, A.H. (1983). Keynes on Monetary Reform and International Economic Order. Tepper School of Business . Monbiot, G. (2008). Keynes is innocent: the toxic spawn of Bretton Woods was no plan of his. Retrieved May 16, 2014, from The Guardian. IMF Staff (2000). Exchange Rate Regimes in an Increasingly Integrated World Economy. Retrieved May 16, 2014, from International Monetary Fund. Read More