International Monetary Fund and World Bank - The imf bretton woods monetary system

The Bretton Woods conference of 1944 produced the most ambitious and far-reaching international economic agreement
between sovereign states in history. By far the most important aspect of these arrangements were the articles that created
the International Monetary Fund and established the rules for global monetary relations. American and British financial
officials, led by John Maynard Keynesand Harry Dexter White, hoped to establish a system that would maintain stable,
fixed exchange rates, allow national currencies to be converted into an asset over which they had no issuing control (gold),
and to provide an effective mechanism to adjust exchange rates in the hopefully rare event that a "fundamental" balance-
of-payments disequilibrium emerged. In the event of nonfundamental deficits that normally arose in international
transactions, the deficit country would pay with a reserve asset (gold or a key currency convertibleinto gold), or seek
short-term financing from the International Monetary Fund, which would supply the currency needed. The IMF was also
assigned the task of overseeing and enforcing these arrangements.
This IMF-guided system was much different from any previous international monetary system. It was not like a traditional
gold standard, where the domestic money supply, and hence the domestic price level, was directly determined by the
national gold stock. Under the gold standard, a balance-of-payments deficit would be paid for through the export of gold,
resulting in a decrease in the domestic money base and a deflationof prices. The decreased purchasing power would lower
that country's imports, and the increased international demand for that country's lower-priced goods would increase
exports, naturally correcting the balance-of-payments deficit. Conversely, an influx of gold, by increasing the domestic
monetary base and domestic prices, had the opposite effect of boosting imports and discouraging exports, thereby
eliminating a payments surplus. According to standard market theory, any balance-of-payments disequilibrium would be
adjusted more or less automatically, eliminating the need for government interference. But the cost of making payments
balance could be very high, and included deflation that caused widespread unemployment in deficit countries. In reality
this system worked much better when capital flows from London, and to a lesser extent Paris, kept the system functioning
smoothly.
The founders of the IMF explicitly rejected the gold standard as a model for future international monetary relations. White
and especially Keynes believed that the interwar experience had demonstrated that a balance-of-payments adjustment
process that relied on deflatingthe economy of a deficit country was draconian in an age when national governments
promised full employment and a wide array of social spending. Decreasing the monetary base in a deficit country would
lead to a fall in national income, unleashing unemployment and necessitating large cuts in government spending. To avoid
such a politically unacceptable system, the Bretton Woods IMF regime allowed nations to import and export gold without
penalty (that is, without having to change their domestic monetary base). If and when balance-of-payments deficits arose
between countries, they would be corrected through short-term IMF financing and small, IMF-approved changes in the
exchange rate. This points to an interesting fact about the Bretton Woods conference and agreement. Although Bretton
Woods was hailed as the hallmark of international cooperation, in reality it provided national economic and political
authorities an unprecedented amount of immunity from the international pressures of the global market. To a large degree,
this was the policy preference of both the United States and Great Britain. Macroeconomic decisions were the sole
province of national governments, which were quick to sacrifice measures that would bring about balance-of-payments
equilibrium in order to achieve important domestic goals.
Because U.S. economic foreign policymakers worried that the existing gold stock was too small to sustain the growing
demand for international liquidity, the Bretton Woods IMF regime was set up to be a two-tiered system in which certain
key currencies—those convertible into gold, such as the dollar and (it was hoped) sterling—could be used in lieu of gold
to settle international transactions. It was hoped that this would conserve the use of gold and dramatically increase the
amount of liquidity available to finance international transactions. This meant that much of the world's reserve
requirements would be supplied through the balance-of-payments deficits of the key currency economies. Why did the
Bretton Woods planners allow such a thing? Keynes recognized that Great Britain would face postwar deficits, and he
wanted a system that did not penalize sterling. Ironically the British economist also feared American surpluses and wanted
to guarantee that the United States fulfilled international liquidity needs.
But it was unclear how large these deficits had to be to fulfill international reserve needs. If the key currency economies
had no deficit, or too small a deficit, then the world would have to rely on gold alone to finance trade. Without key
currency deficits, liquidity would dry up and international transactions disappear. But if the key currency country ran
balance-of-payments deficits that were too large, the resulting inflation would test the value of the key currency and set off
a large-scale conversion of the currency into gold. This would remove valuable liquidity from the system and set off a
fierce competition for gold, with deflationary effects on the international economy. Capital controls, trade restrictions, and
currency blocs might ensue. This made the meaning of British, and to a greater extent, American balance-of-payments
deficits somewhat ambiguous. The system was designed to make deficits necessary, but it was never clear how large or
how small a deficit was needed to supply liquidity without undermining confidence in the value of the dollar.
What were the larger motives of the founders of the IMF plan? U.S. and British foreign and economic policy goals were
often at cross-purposes by 1944. It has often been noted how remarkable it was that Keynes and White, despite the vastly
different economic priorities of the countries they represented, were able to come up with such an extraordinary
compromise. Indeed, Keynes's original proposal envisioned a "currency union" in which countries would have had to pay
a penalty on their surplus payment balances. Additionally debtor nations would have unrestricted and virtually unlimited
access to the resources of the clearing fund without having to seek international approval or make domestic adjustments to
correct payments disequilibria. Keynes's original plan had an enormous inflationary bias, and would have allowed Great
Britain to tap the immense resources of the United States without having to go through the arduous and embarrassing
process of asking for direct aid.
The IMF Bretton Woods systemhas often been portrayed as an attempt to move away from the vicious economic
competition of the late nineteenth and early twentiethcenturies. American policymakers were motivated, it has been
suggested, "by a humanitariandesire to prevent the kind of financial stresses and economic dislocations that might lead to
future wars." The noted policy analyst Judy Shelton summed up the conventional wisdom when she argued in 1994 that
"Keynes and White were convinced that international economic cooperation would provide a new foundation of hope for a
world all too prone to violence. 'If we can continue,' Keynes observed, 'this nightmare will be over. The brotherhood of
man will have become more than a phrase.'"
Keynes's own writings call this interpretation into doubt. Not only would his blueprint protect Great Britain's planned full-
employment policies from balance of payments pressures, it would also present a convenient and politically painless way
to get money out of the United States in the guise of international banking and monetary reform:
It would also be a mistake to invite of our own motion, direct financial assistance after the war from the United States to
ourselves. Whether as a gift or a loan without interest or a gratuitous redistribution of gold reserves. The U.S. will consider
that we have had our whack in the shape of lend lease and a generous settlement of consideration…. We in particular, in a
distressed & ruined continent, will not bear the guise of the most suitable claimant for a dole … On the contrary. If we are
to attract the interest and enthusiasm of the Americans,we must come with an ambitious plan of an international
complexion, suitable to serve the interests of others sides ourselves.… It is not with our problems of ways and means
that idealisticand internationally minded Americans will be particularly concerned.

While the Americans rejected the currency union plan as too radical, the British came up with a substitute in the scarce-
currency clause for the IMF, which permitted extensive capital controls and trade discrimination against major surplus
countries. Roy F. Harrod, a U.S. Treasuryofficial and Keynes protégé, even suggested that the scarce currency not be
discussed in public, for fear that the U.S. Congress might figure out its true implications. Keynes agreed, stating, "the
monetary fund, in particular, has the great advantage that to the average Congressman it is extremely boring." But the
heated debates in Congress over the IMF demonstrated that some Americans had a better understanding of the scarce-
currency clause than Keynes assumed.
The controversial scarce-currency clause was eventually included as Article 7 in the IMF Bretton Woods agreement, but
the Truman administration interpreted its provisions very narrowly. This angered many British policymakers, who in later
years blamed many of Britain's economic woes on the Americans' narrow interpretation of the clause. During deliberations
over whether or not to devalue sterling in 1949, the UK president of the Board of Trade bitterly lamented the American
position:
In particular, United States policy in the Fund has been directed … to making the "scarce currency" clause a dead letter.
We thought originally that this clause might give some real protection against a dollar shortage; indeed, Lord Keynes's
conviction that this was so was one of the main factors which led His Majesty's Government and Parliament to accept the
Loan Agreement. Once the clause comes into operation, it gives wide freedom fordiscriminatoryexchange and trade
controls against the scarce currency; and then there is real pressure on the country concerned to play its full part in putting
the scarcity right, e.g., by drastic action such as we want the United States to take to stimulate imports.

In the end, the British had little to complain about. By the late 1940s the Truman administration's foreign policy goal of
promoting European reconstruction and eventual integration led the United States to permit extensive dollar discrimination
while furnishing billions of dollars of aid through the Marshall Plan. Furthermore, to the surprise of many, the United
States ran consistently large balance-of-payments deficits throughout the postwar period. The problem was not, as Keynes
and White had feared, too little liquidity. The opposite was the case. By the late 1950s and early 1960s, there was a
growing sense that the flood of postwar dollars had become too large, and that measures had to be taken to choke off the
persistent American balance-of-payments deficit.
Why is global economic stability important?
Promoting economic stability is partly a matter of avoiding economic and financial crises, large swings in economic
activity, high inflation, and excessive volatility in foreign exchange and financial markets. Instability can increase
uncertainty, discourage investment, impede economic growth, and hurt living standards. A dynamic market
economy necessarily involves some degree of volatility, as well as gradual structural change. The challenge for
policymakers is to minimize instability in their own country and abroad without reducing the economy’s ability to
improve living standards through rising productivity, employment, and sustainable growth.

Economic and financial stability is both a national and a multilateral concern. As recent financial crises have shown,
economies have become more interconnected. Vulnerabilities can spread more easily across sectors and national
borders.

How does the IMF help?

The IMF helps countries implement sound and appropriate policies through its key functions of surveillance,
technical assistance, and lending.

Surveillance : Every country that joins the IMF accepts the obligation to subject its economic and financial policies
to the scrutiny of the international community. The IMF’s mandate is to oversee the international monetary system
and monitor economic and financial developments in and the policies of its 189 member countries. This process,
known as surveillance, takes place at the global level and in individual countries and regions. The IMF assesses
whether domestic policies promote countries’ own stability by examining risks they might pose to domestic and
balance of payments stability and advises on needed policy adjustments. It also proposes alternatives when
countries’ policies promote domestic stability but could adversely affect global stability.

A- Consulting with member states

The IMF monitors members’ economies through regular—usually annual—consultations with each member
country. During these consultations, IMF staff discusses economic and financial developments and policies with
national policymakers, and often with representatives of the private sector, labor and trade unions, academia, and
civil society. Staff assesses risks and vulnerabilities, and considers the impact of fiscal, monetary, financial, and
exchange rate policies on the member’s domestic and balance of payments stability and assesses implications for
global stability. The IMF offers advice on policies to promote each country’s macroeconomic, financial, and balance
of payments stability, drawing on experience from across its membership.

The framework for these consultations is set forth in the IMF Articles of Agreement and the Integrated Surveillance
Decision. The consultations are also informed by membership-wide initiatives, including

work to systematically assess countries' vulnerabilities to crises;

the Financial Sector Assessment Program, which assesses countries’ financial sectors and helps formulate policy
responses to risks and vulnerabilities; and
the Standards and Codes Initiative in which the IMF, along with the World Bank and other bodies, assesses
countries’ observance of internationally recognized standards and codes of good practice in a dozen policy areas.
B- Overseeing the bigger picture

The IMF also closely monitors global and regional trends.

The IMF’s periodic reports, the World Economic Outlook, its regional overviews, the Fiscal Monitor, and the
Global Financial Stability Report, analyze global and regional macroeconomic and financial developments. The
IMF’s broad membership makes it uniquely well suited to facilitate multilateral discussions on issues of common
concern to groups of member countries, and to advance a shared understanding of policies needed to promote
stability. In this context, the Fund has been working with the Group of 20 advanced and emerging economies to
assess the consistency of those countries’ policy frameworks with balanced and sustained growth for the global
economy.
The Fund has reviewed its surveillance mandate in light of the global crisis. It has introduced a number of reforms to
improve financial sector surveillance within member countries and across borders, to enhance understanding of
interlinkages between macroeconomic and financial developments, and stimulate debate on these matters. The IMF
has also strengthened its analysis of macro-critical structural reforms to the macroeconomy to help countries
promote durable and inclusive growth.

Data : In response to the financial crisis, the IMF is working with members, the Financial Stability Board, and other
organizations to fill data gaps important for global stability.

Technical assistance : The IMF helps countries strengthen their capacity to design and implement sound economic
policies. It provides advice and training in areas of core expertise—including fiscal, monetary, and exchange rate
policies; the regulation and supervision of financial systems; statistics; and legal frameworks.

Lending : Even the best economic policies cannot completely eradicate instability or avert crises. If a member
country faces a balance of payment crisis, the IMF can provide financial assistance to support policy programs that
will correct underlying macroeconomic problems, limit disruption to both the domestic and the global economy, and
help restore confidence, stability, and growth. The IMF also offers precautionary credit lines for countries with
sound economic fundamentals for crisis prevention.