Rachel E. Cononi andRebecca Hellerstein

Research Assistants, Federal ReserveBank of Boston. This article sutnma-rizes a session of the annual meeting ofthe Eastern Economic Association,March 18, 1994. The authors thankJane Sneddon Little for helpful com-ments.

T his Eastern Economic Association roundtable discussion, held onMarch 18, 1994 at the Federal Reserve Bank of Boston, examinedthe future of the international monetary system in light of the

aims of the Bretton Woods agreement of 1944. The title of the roundtablecaptures the central concern of each speaker: To what-extent can theideals of the founders of the Bretton Woods system be implementedtoday, given the changes in underlying economic qonditions since thattime?

Each speaker offered a distinct response to that question, drawnfrom the unique perspective of his background. J. Dewey Daane, aprofessor at Vanderbilt University, offered a historical perspective as heintroduced the panel. Charles Taylor, Executive Director of the Group ofThirty and Project Director of the Bretton Woods Commission, gavesome of his personal views on directions the International MonetaryFund and the monetary system might take. Richard Erb, DeputyManaging Director of the International Monetary Fund, explained thecurrent process of international monetary collaboration among its mem-bers known as IMF surveillance. Scott E. Pardee, Chairman of thesecurities firm Yamaichi International (America) Inc., argued that theinternational monetary system functions effectively only when marketparticipants can ally themselves confidently with the stated monetarypolicies of national governments. And Stefan Schoenberg, ExecutiveDirector for Germany at the IMF, emphasized that currency competitionin today’s world is basically policy competition. Moderator for the panelwas Richard F. Syron, President of the Federal Reserve Bank of Boston.

Introductory Remarks: A Historical PerspectiveJ. Dewey Daane introduced the roundtable, noting that while the

focus of the discussion to follow clearly would be on "where we go from

The Bretton Woods Payments System: A Brief Histomd

The establishment of a new and more stable systemof multilateral trade and payments was one of the mostimportant tasks facing world leaders at the close of thesecond World War. Delegates from 44 nations gatheredat Bretton Woods, New Hampshire in July 1944 with acommon vision--to devise a monetary system thatwould encourage international cooperation. They weredriven to reform the international monetary system byfears of a return to the dramatic slumps and booms thatscarred the interwar years. During the Great Depres-sion, the system of gold convertibility that had been inplace since 1880 came to a grinding halt. The years thatfollowed were characterized by fluctuating exchangerates, competitive devaluations, and increasing use ofrestrictive trade practices.

The Bretton Woods delegates designed a frame-work for a new payments system intended to promoteeconomic recovery and the expansion of trade. Theconferees laid the foundation for their new monetaryregime in the Articles of Agreement of the InternationalMonetary Fund, which provided for a system based onpegged but adjustable exchange rates and an institution,the International Monetary Fund (IMF), that wouldadminister the system, operate as a central bank forcentral banks, and assist countries experiencing periodicbalance of payments difficulties. The Fund Agreementprovided for a system of international credits, availableto member countries to finance temporary balance ofpayments difficulties; currency convertibility, at least forcurrent account transactions; and the prohibition ofdiscriminatory currency practices.

The new monetary regime did not become fullyoperational until 1958 when, after an extended period ofpostwar reconstruction, European currencies becamefully convertible. The strengthening of European curren-cies in the late 1950s mirrored the increasing weaknessof the U.S. dollar, however. The dollar’s weakening,accompanied by repeated challenges to the internationalmonetary system, gradually led to an erosion of confi-dence in the system.

By the early 1960s, the U.S. dollar had becomeovervalued relative to gold and other currencies. Gov-ernment persistence in maintaining fixed exchange ratesin the face of fundamental payments imbalances led toheavy speculation. Disequilibria built up, resulting in aseries of currency crises that progressively underminedthe fixed-rate system. Indeed, one fundamental weak-ness in the key currency system established at BrettonWoods was that it required the United States to runbalance of payments deficits in order to supply othercountries with needed liquidity through increased for-eign exchange reserves. Supplying this liquidity whilemaintaining a fixed exchange rate resulted in U.S. goldreserves becoming increasingly inadequate to guaranteedollar convertibility at $35 per ounce, further erodinginternational confidence in the Bretton Woods system.

A variety of solutions were proposed regarding the

reform of the international liquidity mechanism, butdecisive action was not taken until March 1968, whenthe IMF created Special Drawing Rights (SDRs), a newreserve asset to substitute for dollars. By 1969, however,the international economy was experiencing severestrains and the convertibility of the dollar was increas-ingly in doubt. In addition, lowered barriers to capitalflows accelerated the speed with which dollars could betransferred from the United States to Europe. Withenormous pools of capital becoming increasingly mo-bile, the maintenance of fixed exchange rates becameever more difficult. In August 1971, U.S. PresidentRichard M. Nixon shocked the world with his announce-ment to set the dollar loose from gold.

Nixon’s startling announcement prompted theSmithsonian Agreement of December 1971, a last-ditchattempt by the ministers and governors of the Group ofTen to save the Bretton Woods system. The agreementprescribed devaluation of the dollar against gold, amultilateral realignment of exchange rates, and expan-sion of the narrow bands of fluctuation around thenewly fixed values. In addition, the EC Snake, a techni-cal mechanism for aligning currency movements withinthe European Economic Community, was created. De-spite these measures, the revised system fell apart afterlittle more than a year.

In April 1973, the exchange rates of all majorindustrial countries began to float against the dollar.During this time the IMF’s Committee of Twenty at-tempted to reconstruct international monetary institu-tions on the basis of pegged exchange rates. Their effortscollapsed, however, in 1974.

The regime that eventually emerged was based onmanaged, flexible exchange rates. In January 1976, theSecond Amendment to the Fund Agreement ratified theinternational laissez-faire system that had taken holdafter the demise of the Bretton Woods payments system.According to the amendment, the stability of exchangerates was to be sought through the stability of underly-ing monetary and fiscal policies rather than by pegging;floating rates were to be subject to a process of surveil-lance by the 1MF; the roles of gold and the dollar were tobe reduced, with the SDR eventually becoming theprincipal reserve asset; and finally, the fixed official priceof gold was abolished.

Since then, the international monetary system hasevolved still further in order to keep pace with eco-nomic, political, and technological changes. As a result,we have witnessed a gradual departure from a regime offixed exchange rates to a system of managed but rela-tively flexible exchange rates. Some would argue thatthis flexible regime has contributed to higher inflationand slower growth in GDP in the OECD countries overthe past two decades, underlining the need for furthermultilateral cooperation. Though discussions on reformof the current system have been constant, a consensushas yet to be reached.

66 July/August 1994 New England Economic Revi~v

here," an inextricable link to the Bretton Woodsexperience remained, in spirit and reality. One must,in his view, answer the question "Did the BrettonWoods System succeed or fail?" by responding"Both."

The success of Bretton Woods enabled and rein-forced an unprecedented expansion in world tradeand payments over more than a quarter century. TheBretton Woods agreement led to the elimination ofexchange controls and other restrictions in trade andpayments and to the restoration of convertibility ofcurrencies among major countries. It also establishedshort-term credit facilities that proved to be an im-portant source of assistance to countries in temporarybalance-of-payments difficulties. These facilities stillplay an important role in today’s system.

Daane cautioned that the sameinstruments that have been

developed to cover risk and addliquidity and stability can also beused to speculate, leading instead

to increased instability.

The Bretton Woods system failed, however, inthree important respects, all relevant today. First, itfailed to achieve an adequate adjustment processwhereby countries would take the necessary mea-sures, both external (for example, exchange rateactions) and domestic (mainly fiscal and monetaryactions), to correct serious imbalances in their balanceof payments positions. The Bretton Woods systemfailed in this because of its inability to ensure thatcountries would take these necessary correctivesteps, an essential element in any effective interna-tional monetary system. Second, it failed to providefor the secular growth in world monetary reservesneeded to accompany a growing world economy anda relatively fixed-rate system. Bretton Woods initiallyprovided for expansion of borrowed reserves, but notfor flexible additions to owned reserves. And third,Bretton Woods failed to provide means to cope withspeculative capital movements, which time after timeprovoked an international monetary crisis.

Drawing on his personal role in the work of theCommittee of Twenty (The Committee on Reform of

the International Monetary System and Related Is-sues) to develop a blueprint for reform in the early1970s, Daane described the four facets of an effectivesystem from the perspective of that Committee: 1) asmoothly functioning adjustment process; 2) ade-quate liquidity, in terms of both borrowed and ownedreserves; 3) a system that could deal with speculativecapital flows; 4) a system that could accommodate theneeds of developing countries. The Committee didnot discard the idea of an exchange rate regime basedon stable but adjustable par values, but it recognizedthat floating rates might provide a useful technique inparticular situations.

Daane asserted that the history of the BrettonWoods agreement and the attempts at its reformcontains lessons that are applicable today. It is nolonger realistic to visualize a return to a relativelyfixed-rate system in the Bretton Woods tradition, hedeclared, because the conditions for such a return areno longer in place. This became clear in the morerecent difficulties of the European Monetary System,which was a microcosm of Bretton Woods. Thequestion then becomes, how can we improve a sys-tem with floating rates and free (and instantaneous)capital movements? A glaring weakness in currentmonetary arrangements, according to Daane, hasbeen the marked volatility of exchange rates. Yet theworld has survived and prospered, and we mayinstead need a new concept or criterion of stability.Our earlier concept assumed that unstable exchangerates would be excessively detrimental to the growthof world trade, but this does not appear to havenecessarily been the case.

A final lesson Daane drew was that the world-wide monetary system is now more vulnerable to thethreat of systemic risk than it was at the time ofBretton Woods. He cautioned that the same instru-ments that have been developed to cover risk andadd liquidity and stability can also be used to specu-late, leading instead to increased instability.

The Views of Current ReformersCharles Taylor considered the future of the in-

ternational monetary system from the perspective ofa modern-day reformer. He recalled that the found-ing fathers of Bretton Woods developed a coopera-tive, multilateral system, with the International Mon-etary Fund at its center to provide the advice andfinancing to help overcome international paymentsimbalances and to encourage the liberalization of

July/August 1994 New England Economic Review 67

international trade and payments. Although their parvalue system of fixed but adjustable exchange rateseventually broke down, in many respects their visionhas proven both sound and durable.

Taylor traced recent monetary history and cri-tiqued the present international monetary systemfrom the viewpoint of the original Bretton Woodsdelegates. He imagined the delegates expressing sur-prise at the variety of financial services and financialinstruments now available, the many types of finan-cial institutions and the extent to which their activi-ties overlap, and the sophisticated methods of man-agement within these institutions. Other changessince Bretton Woods include the emergence of globalmarkets, the growth in cross-border capital flows,and the displacement of credit markets by capitalmarkets, along with the routine speed of transac-tions, the volatility of prices, and the emergence ofsophisticated information systems. The delegatesmight also be surprised by the way in which theregulation of financial markets has fallen behind; byhow ubiquitous uncertainty is; how ineffective fiscalpolicy has become; and how new and influentialorganizations like the G-7 and the European Commu-nity have sprung up alongside the IMF.

Taylor speculated that the Bretton Woods dele-gates would be troubled by recent economic perfor-mance in the OECD countries. Comparing the periodfrom the 1950s to the 1970s, the days of the par valuesystem, to the years that followed, Taylor noted thatgrowth of real GNP declined and structural unem-ployment rose; the rate of growth in the trade ofgoods and services slowed while cross-border invest-ment flows surged; and savings and investments as ashare of GNP fell while public sector deficits grew,facilitated by the growth of international capital mar-kets. One bright spot was inflation; "let out of thebag" in the early 1970s, it has been "squeezed back inagain" since the early 1980s. Taylor attributed thepoor recent performance overall to a general deterio-ration in fiscal policy, and to the occasional extremecurrency volatility and misalignments of exchangerates that have recurred since the early 1970s.

Taylor noted the striking divergence between theincrease in microeconomic efficiency in the interna-tional financial system and the decrease in the qualityof overall macroeconomic performance. In the light ofthis disappointing record, he posed two questions:"How much of the problem is international in char-acter and amenable to concerted multilateral action?"and "What are the public goods that can and shouldbe provided through multilateral cooperation?" Tay-

lor identified three such public goods: first, an envi-ronment that fosters efficient global capital markets.In the past, this entailed liberalizing payments andcapital movements and establishing stable exchangerates. Now, however, limits on excessive volatilityand persistent disequilibria must also be considered.Second, sustainable and coordinated macroeconomicpolicies. Fifty years ago, this meant macroeconomicpolicies compatible with the agreed exchange rateregime and with stable domestic prices. Today, long-er-term structural adjustments must be undertaken toachieve this. Third, confidence in money and in thestability of financial institutions. In the past this wasfirst and foremost a national responsibility: today thisrequires global cooperation in financial regulation,stretching beyond banks into other types of financialintermediaries.

Taylor noted the strikingdivergence between the increasein microeconomic efficiency in

the international financialsystem and the decrease in

the quality of overallmacroeconomic performance.

The basic nature of the public goods neededtoday is similar to that of 50 years ago, but no con-sensus now exists on how to provide them. Withregard to globally efficient capital markets, "financiallibertarians" are at odds with those who favor somedemarkation of acceptable limits to price movements,such as target zones for exchange rates. Many oftoday’s policymakers can envision few alternatives tothe present ad hoc approach to policy coordination,even though many outside observers would prefermore structure. Taylor attributed the current lack ofconsensus on global systemic issues to the fact thatalthough substantial progress has already been madeon the sub-issues using a pragmatic approach, ourthinking about the subject as a whole remains at arelatively early stage.

Taylor expressed uncertainty on how the systemwill evolve. Existing problems in the internationalmonetary system do give substantive reason for con-cern. The Bretton Woods Commission, the group of

68 JulyMugust 1994 New England Economic Review

senior private sector individuals for which Taylor isthe Project Director, will shortly publish its proposalsfor reform: They should be a major contribution towhat looks like a vigorous public debate shaping upin the next few months.

The Role of InternationalMonetary Collaboration

Richard Erb described the functions of the Inter-national Monetary Fund and the evolution of IMFsurveillance, a now-routine process of internationalmonetary collaboration among IMF members. TheIMF Articles of Agreement state that "the essentialpurpose of the international monetary system is toprovide a framework that facilitates the exchange ofgoods, services, and capital among countries and thatsustains sound economic growth," a mandate thatIMF surveillance seeks to carry out.

Following the breakdown of the fixed exchangerate regime in the 1970s, an agreement on a newregime could not be reached. The general consensuswas that in order to reestablish exchange rate stabil-ity, it was first necessary to achieve "orderly under-lying conditions" in those economic developmentsand policies that have a significant impact on acountry’s exchange rates. The need to focus on these"underlying conditions" led to the development ofthe collaborative procedure known as IMF surveil-lance. For each member, at least once a year, IMF staffconduct an in-depth examination of its economy,paying particular attention to monetary, budget, andexchange rate developments and policies, as well aslabor markets and other structural areas. The IMFExecutive Board assesses the results of this examina-tion, which are then presented to the member’sgovernment. Analyses are also prepared for meetingsof the G-7 countries, and twice annually the IMFWorld Economic Outlook is issued.

These surveillance consultations enable the IMFmembership, through its representatives on the Ex-ecutive Board, to assess if a country’s underlyingeconomic conditions can support sustainable growth,as well as domestic and external financial stability.Member governments generally accept the analysis ofthe Fund but are not obligated to adopt its recom-mendations. Often, it proves difficult to garner thenecessary domestic political support to implementthe recommended fiscal actions.

No limitations are placed on national sovereigntyover economic policies and IMF surveillance seeks to

influence member policies through good analysis andpeer pressure. Erb believes that any effort to imple-ment a fixed exchange rate regime in order to imposeexternal discipline on domestic policies would receivea negative response from the IMF membership. Thisgeneral attitude has not precluded regional efforts,however, such as the European Community’s ex-change rate mechanism, and much can be learnedfrom them.

Erb went on to describe the spread of outward-looking, market-based reforms in both developingand formerly centrally planned economies, a devel-opment that will profoundly affect the evolution ofthe international monetary system. Over the years,

Erb noted that one byproduct ofmacroeconomic developments inLatin America, Africa, EasternEurope, and Asia has been an

increase in IMF membership fromalmost 150 countries in the late

1980s to nearly 180 today.

the IMF has assisted many countries’ efforts to imple-ment sound budget and monetary policies and toestablish unified exchange rates and current andcapital account convertibility. The positive economicperformance of those developing countries in Asiathat in the 1960s and 1970s chose outward-lookingeconomic policies, combined with prudent monetaryand budget policies, has encouraged other develop-ing countries in Latin America and Africa to pursuesimilar policies.

In the late 1980s, a still more dramatic transfor-mation began in many Eastern European and Asiancountries with centrally planned economies. Theirtransformation has not been easy, but Erb expressedconfidence that current macroeconomic and market-based reforms will shepherd these countries to highgrowth paths and eventually integrate them morefully within the larger world economy. One byprod-uct of all these developments has been an increase inIMF membership from almost 150 countries in thelate 1980s to nearly 180 today, affecting both theframework of cooperation within the IMF and theevolution of the international monetary system.

July/August 1994 New England Economic Review 69

The Role of Business andGovernment in Volatility

Scott E. Pardee observed how both business andgovernment, in vain, desire a stable exchange rateregime. He believes that managed volatility is pre-ferred even by those market participants who maketheir living betting on currency trends. Pardee re-called that when in October 1960 the price of goldbroke out of the tight band set for it under the BrettonWoods system, he experienced the break as a pro-foundly moving event for the future of the internationalmonetary system. Today, in contrast, similar shocks arefrequent and violent, each one affecting the interna-tional monetary system and the profitability of anyposition he, or his company, may have in the markets.

In an international monetary system that works,according to Pardee, market participants who bet

In an international monetarysystem that works, according toPardee, market participants who

bet with the government should bethe ones who make the profits, not

those who bet against it.

with the government should be the ones who makethe profits, not those who bet against it. Unfortu-nately, some of the biggest profits to foreign ex-change traders in recent years were made in 1992 and1993 by those market participants who bet that theEuropean Monetary System (EMS) would breakdown, and again in 1993 and 1994 by those traderswho bet that the United States, in a fit of pique overJapan’s trade surplus, would choose to jawbone theyen higher against the dollar. In contrast, marketparticipants who bet that governments’ stated poli-cies would ultimately prevail, that the EMS wouldlead to greater exchange rate stability and that theUnited States would not manipulate exchange rates,sustained the largest losses.

Pardee defined two issues as central to the fail-ures of the international monetary system since theend of the original gold standard, in the 1930s. First,when governments seek to stabilize exchange ratesby setting par values or narrow limits of fluctuation

for their currencies, they often hold out too longagainst market forces, leading to runs on the ex-change market that they chnnot control. Second,when governments adopt floating exchange rates,sooner or later they revert to unilateral dirty floating,depreciating their currencies to achieve domestic eco-nomic policy objectives.

Business and government have a strong desirefor stable exchange rates for reasons of expediency:the existence of separate currencies results in anadditional transaction cost for anyone making inter-national payments. Volatility also adds to the cost ofdoing business internationally; the greater the vola-tility, the greater the cost until volatility itself maychoke off the international flow of goods and capital.The expansion of the markets for swaps and otherderivative products reflects the basic desire by manymarket participants to transfer volatility risks to oth-ers. Even those market participants who take theserisks, however, prefer volatility that is reasonablypredictable. An efficient international monetary sys-tem must provide broad, deep, and resilient marketsfor both cash transactions and for the whole array ofvolatility-driven derivative products.

Governments can achieve foreign exchange ratestability only in the nexus of conflicting domesticpolicy objectives. For governments that choose to fixtheir exchange rates with other currencies, determin-ing when the exchange rate is or is not out of linebecomes a discrete policy choice. When the marketsenses that a government is reviewing that policychoice, traders are quick to bet that the change will bemade. To the extent that many traders jump on thesame bandwagon, the amount of money they canmove into one currency and out of another oftenmakes their bet a self-fulfilling prophecy.

A government must manage its domestic affairswell if its exchange rate is to remain in a stable relation-ship with other currencies. Pairs of countries havemanaged this, but in each successful case, exchangerate stability came as a result of frequent and occasion-ally profound domestic economic policy adjustments,and after years of building up credibility in the market-place. Democratic governments have a special problemin achieving credibility because their policies are ac-tively debated in the marketplace. Financial officialshave a continuing responsibility to keep debate withinthe government on track. Fixity of exchange ratesremains a goal, but surveying recent monetary history,Pardee noted that the collapse of the Bretton Woodssystem in 1971-73 and of the EMS in 1992-93 is not anencouraging track record for the near future.

70 July/August 1994 New England Economic Review

A monetary system can function efficiently onlywhen confidence exists in the stability of its money asa unit of account and as a standard of value. Whengovernments shake that confidence by manipulatingexchange rates, they damage the system. Here, too,the record over the past 50 years has been discourag-ing, and the U.S. government has been the biggestculprit in currency manipulation. Recent Administra-tions have all succumbed to the arguments of U.S.industrialists and economists that other currenciesshould appreciate against the dollar. Such a policyhas several drawbacks: It is inflationary for theUnited States, it causes foreign investors to shy awayfrom buying American securities, and it invites retal-iation by foreign governments.

Recommendations for the FutureInternational Monetary System

In the near future, the international monetarysystem must be protected against possible, internalbreakdowns to reduce risks to the system as a whole.The economic and technological challenges posed bynew markets, the information superhighway, the pro-liferation of derivative products, and other changes willbe profound. Governments must pursue effective sta-bilization policies, sustaining growth with a minimumof inflationary pressures and avoiding excessive tradeor capital account imbalances. The international mone-tary system needs new leaders of vision, like those atBretton Woods, the founding of the European Pay-ments Union, the European Monetary System, or evenMaastricht, to shape its institutions. Although the Bret-ton Woods delegates may have been parochial in theirinsistence on details that favored their national inter-ests, what emerged was a collective, coherent view ofthe international monetary system as it should be. Morerecent agreements have lacked this insight.

Pardee concluded by reflecting on the writings ofWilliam McChesney Martin, a former Chairman ofthe Federal Reserve, on the possibility of a world centralbank. Although it probably could not be achievedunder the nation-state political system, Martin’s visioncould provide an important sense of direction to theinternational monetary system, an alternative to con-fronting each monetary crisis as it comes.

The Importance of DomesticFiscal Responsibility

Stefan Schoenberg noted that the entire globemay soon be included in the international monetary

system. Throughout his presentation he emphasizedthat in a world of fully integrated financial markets,currency competitiveness was very much tantamountto policy competitiveness. In this context, he stressedthe importance of domestic fiscal responsibility inmaintaining exchange rate stability. Any interna-tional monetary system or "order" must provideanswers to the following basic questions: 1) To whatextent are international transactions liberalized orsubject to controls? 2) How are exchange rates deter-mined? 3) Which currencies function as "internation-al money" (that is, as reserve, investment, interven-tion, and transaction currencies)? 4) Through whatmechanism is international liquidity supplied?

Countries that want tobenefit from free capitalmovements must accept

impairment of their economicpolicy sovereignty, according

to Schoenberg.

Schoenberg noted that the founders of BrettonWoods proposed that the freedom of internationalcapital movements take a backseat to the objective offixed exchange rates, and they limited their aims toremoving restrictions on current transactions. Today,in contrast, we are confronted not only with a globalmarket for goods and services but, increasingly, aglobal financial market as well. Countries that wantto benefit from free capital movements must acceptimpairment of their economic policy sovereignty,according to Schoenberg. Large changes in capitalflows can make domestic policymaking difficult, butattempts to discipline that market will fail, since it isimpossible to distinguish between "good" and ’q~ad"capital transactions. Analysis undertaken by the IMFindicates, however, that most of the policy changesforced by international capital markets seem to havebeen in the right direction.

Schoenberg claimed that the present "non-sys-tem" remains the only functioning solution to thedetermination of exchange rates at this time. A fixed-rate system would threaten the autonomy of eco-nomic policies which the major industrial countrieswant to preserve, despite all their cooperative efforts.

July/August 1994 N~o England Economic Review 71

Countries that intend to maintain a fixed exchangerate system at the regional level, such as the Euro-pean Monetary System, must acknowledge that todo so requires at least partial surrender of policyautonomy.

Current problems with volatility and misalign-ment of exchange rates can be settled, in the longrun, only if major industrial countries pursue a con-sistent and credible economic policy that can stabilizethe expectations of market participants, and thusreduce exchange rate fluctuations. To the extent thatnational economic policies are undisciplined or inef-fective, or lack consistency in policy objectives, effortsto maintain exchange rates will lack credibility, leav-ing room for significant swings in nominal and realexchange rates.

The international monetary regime will doubt-less remain a multicurrency system for some time,Schoenberg declared. With the decline in the inter-national use of the U.S. dollar since World War II,other currencies, most notably the deutsche markand the yen, serve as nominal anchors in theirrespective regions. A future international monetarysystem may be multipolar, with "loose" exchangerate commitments between the poles and "tighter"commitments by some of the countries around thepoles. The availability of alternative internationalcurrencies has a strong advantage over the postwarBretton Woods dollar-based system, in so far as itstimulates beneficial policy competition between thevarious anchor currencies.

A national currency used as "international mon-ey" must be convertible in terms of both current andcapital transactions. There must be confidence in thestability of the currency and the policies of the coun-try that issues it, and financial markets must meetinvestors’ needs. The U.S. dollar remains, by far, themost significant reserve and investment currency andit plays an outstanding role as a transaction currencyfor international commodity trade and in foreignexchange transactions. The deutsche mark owes itsstatus as the second most important currency primar-ily to its above-average stability. The deutsche markfunctions both as an anchor in the EMS, providinginterest rate leadership, and as the main interventioncurrency in both EMS countries and in non-EMScountries linked to the EMS. In contrast, despiteJapan’s growing importance as an exporter of goodsand long-term capital, its payments practices withneighboring countries and their official reserves showthat a distinct "yen zone" does not yet exist. There-fore, the formation of a symmetric tripolar world

monetary system remains some time off. Accordingto Schoenberg, market forces will continue to deter-mine how the international monetary system devel-ops, as they have for the past two decades.

Concerns about international liquidity, Schoen-berg’s final question, now relate more to its distribu-tion than its adequacy. The supply elasficity of themarkets has proven generally adequate to satisfy anyjustified global demand for reserves. Earlier concernsthat led to the creation of the Special Drawing Rightssystem did not materialize and are unlikely to do soin the future. The fact that many countries do nothave access to private sources of liquidity or must payhigher spreads when borrowing in international fi-nancial markets reflects mainly past economic policyfailures. High costs in borrowing reserves thus serveas an indispensable indicator of the need for macro-economic policy changes. In Schoenberg’s opinion,governments or international institutions would notmake more rational decisions about credit allocationthan the market.

Schoenberg concluded with comments on thefuture of monetary policy in Europe. In 1999, Euro-pean Union member countries deemed matureenough are to form a monetary union and introducea common currency. Market behavior has made itrudely clear over the past 18 months, however, that along road remains to the achievement of a singlecurrency in Europe. Institutional arrangements mustbe in conformity with the market’s assessment, be-cause if the two clash, market forces inevitably pre-vail. For too long, financial markets fixated exces-sively on the final goal of European monetary union,mistakenly assuming that the success of future con-vergence efforts could be predicted by fixing ex-change rates. To regain their credibility, EuropeanUnion central banks must recognize that improvingconvergence is a long-term job requiring the coordi-nated action of all member states, not solely anexchange rate constraint.

ConclusionIn their remarks and in the discussion that fol-

lowed, each speaker agreed that a return to a fixed-rate system, as envisioned by the founders of theBretton Woods system, is not possible today giventhe changes in underlying economic conditions sincethat time, in particular, the high degree of integrationof financial markets. Each examined the damagingeffects of fiscal imbalance and volatility on current

72 July/August 1994 New England Economic Reviezo

regimes, both floating and relatively fixed, such asthe European Monetary System, and as a result, onthe world economy. Daane remarked that unstableexchange rates have not been excessively detrimentalto the growth of world trade, however.

To limit volatility, Schoenberg, Pardee, and Tay-lor emphasized the need for better fiscal policy, stableexchange rates, and consequent domestic policy com-promises. Schoenberg pointed out that a stable inter-national monetary system requires that institutionalarrangements coincide with market expectations.Along similar lines, Pardee remarked that marketparticipants who bet with governments should profit,not those who bet against them, as has recently beenthe case. Erb stressed the importance of IMF surveil-lance to encourage responsible fiscal policy by IMFmembers and, thus, limit volatility. He focused,uniquely among the speakers, on the important role

that developing economies in Asia, Latin America,and Africa, and the formerly centrally planned econ-omies in Eastern Europe will play in the internationalmonetary system in the near future. Pardee andTaylor alluded to the possibility of institutional re-form in the near future, with Pardee advocating aworld central bank as a possible long-term goal forpresent reform efforts.

All agreed that different arrangements willemerge by which individual countries can choose,through formal or informal reciprocal agreements, topeg their currencies to one another, eventually creat-ing clusters of linked currencies. This process maylead to a more stable, multipolar international mon-etary system in the twenty-first century, with severalcurrencies acting as anchors in their respective re-gions, a possible future implementation of the origi-nal goals of Bretton Woods.

July/August 1994 New England Economic Review 73