International Coordination of Economic Policy
Author: J. J. Polak1
  • 1 0000000404811396 Monetary Fund

This is a translation of a paper prepared for the meeting on December 9, 1961 of the Vereniging voor de Staathuishoudkunde (Netherlands Economic Society). The paper is addressed to the following terms of reference:


This is a translation of a paper prepared for the meeting on December 9, 1961 of the Vereniging voor de Staathuishoudkunde (Netherlands Economic Society). The paper is addressed to the following terms of reference:

This is a translation of a paper prepared for the meeting on December 9, 1961 of the Vereniging voor de Staathuishoudkunde (Netherlands Economic Society). The paper is addressed to the following terms of reference:

I(A). To what extent is there national and international compatibility between countries’ objectives of (1) reasonable price stability, (2) full employment and an adequate rate of growth, and (3) balance of payments equilibrium? Is it advisable in this connection to set international norms with respect to (a) the concrete content of these national equilibrium objectives, (b) the margins up to which temporary deviations from these norms can be considered acceptable, and (c) the choice and intensity of use of national instruments to avoid or correct such deviations?

I(B). What role should be played in this connection by periodic consultation, international guidelines, or “rules of the game”?

I(C). What could be done if, in spite of the attempts at harmonization under 1(A) and 1(B), serious deviations from the equilibrium norms occur or threaten to occur? Should, in those circumstances, priority be given to particular objectives? To what extent can countries be expected to make particular adjustments even if the disturbance of equilibrium is not attributable to errors of policy on their part?

II. What role can be played by existing organs, such as the Organization for Economic Cooperation and Development and the International Monetary Fund—or by new organs to be created—to achieve coordination of economic policy on a world scale?


The Terms of reference for the papers for this meeting make sharp distinction between a number of specified objectives of economic policy and the instruments available to achieve these objective. While such a distinction is useful in the treatment of some problems, it suffers from notable disadvantages in the present context. The need to coordinate action internationally arises not so much from differences in national objectives as from countries’ desires to limit the use they have to make of various policy tools. In this connection, particular attention centers on the rate of exchange and disequilibrium in the balance of payments: stability of the exchange rate is generally accepted as an important intermediary goal, while the possibility of a temporary deficit or surplus in the balance of payments represents a valuable means to realize the national price and employment objectives in a world subject to dynamic development. In the last ten years, the industrial countries1 have in general been able to reverse disequilibria in their balances of payments without sharp deviations from their price and employment objectives and without changes in the rates of exchange.

An analysis of attempts at international coordination of national policies leads to the conclusion that true international action—as distinguished from multifarious international discussions of an informational character—has a good chance to succeed for specific measures, such as changes in exchange rates, customs tariffs, and perhaps (in the future) discount rates. There is, on the other hand, little reason to assume that the desire prevalent in all countries for full employment, stable prices, and growth could be supported to any important degree by the acceptance of international obligations.

The extent to which diverging national objectives can be absorbed by the balance of payments depends on the international reserves at countries’ disposal and on the supplementary means that countries can acquire. The growth in the last few years of the drawing potential in the International Monetary Fund—it represents now nearly one fourth of total international liquidity—has given the Fund a central role in coordinating the economic situations in different countries. In the present international monetary system, the Fund represents a “managed” successor to the “automatic” gold standard.

I. National Objectives and Instruments

Targets and Instruments

The targets of economic policy as they have been put forward for our discussion appear simple and noncontroversial: reasonable price stability, full employment and an adequate rate of growth, and balance of payments equilibrium. With or without the qualifiers, “reasonable” to price stability and “full” to employment, these are on everyone’s list of general targets. They are the typical targets in the numerous examples in Tinbergen’s handbook;2 they are listed as the accepted “primary objects of policy” in the most recent Report of the Netherlands Bank;3 they constitute the list in the Radcliffe Report except that this Report calls for a surplus rather than equilibrium in the balance of payments.4

If in any country the relationship between wages and employment is such that at full employment wages increase more rapidly than is compatible with price stability, then obviously the price and employment objectives of that country are not compatible. But if in one way or another each country reconciles its own price and employment objectives, and it is willing to use freely the various policy tools available to it, there is nothing in the international setting that prevents it from attaining its objectives,5 whether these are full or less than full employment, stable or rising prices, balance of payments equilibrium or disequilibrium.

The need for international action does not arise, in short, from the international incompatibility of objectives, but from the desire to minimize the use of instruments. This points to a serious difficulty in making a valid distinction between targets and instruments, particularly in situations that are not catastrophical in nature.

Targets are the variables with respect to which we want to achieve particular values; instruments are those variables which we manipulate in order to achieve our targets. The distinction can also be put in this way: targets refer to variables for which we care; instruments, to those for which we do not care. We are preoccupied by the degree of employment, the extent to which prices run up or creep up; we are far less interested in interest rates or exchange rates.

But is this a good general description of our feelings? It seems to reflect reasonably well the situation in the thirties—that abnormal period which still, to a large extent, colors our economic science and our economic outlook. When things were as bad as they were then, in terms of unemployment or price deflation, it was natural for economists to be fully prepared to manipulate some less important variables in order to bring about immediate social and economic improvements. In present circumstances, however, with the main targets more nearly achieved, the distinction between the variables that matter and those that do not matter is not nearly so precise. We observe that a moderate decline in industrial production, or some increase in unemployment, is described as a “healthy readjustment” or a “relaxation of excessive tension in the economy.” At the same time, we become increasingly aware of emotional attachments to the present values of instruments and predilections for the use of particular instruments. A flexible tax policy may be difficult to reconcile with the prerogative of the legislature to determine taxation; the principle of noninterference by governments in labor contracts makes a wage policy impossible. These hesitations about the free use of what might be considered convenient instruments reflect an intuitive awareness of (1) the incompleteness of brief lists of targets, such as those listed at the start of this paper, and (2) the incompleteness of many policy models in which long-run effects often fail to be allowed for properly. Before we reject as irrational the sometimes strong sentiments we meet with respect to the use of various instruments, we should ask ourselves whether these taboos are not perhaps justified by certain economic relationships which we have not been able fully to explore.

Once we have a reasonably high degree of fulfillment of our objectives, the attempt to obtain an even higher degree might require the use of some instruments to an extent that would have more deleterious effects on our target variables, in the long run, than the rather minor present deficiencies that we are trying to overcome. While exchange rate manipulation may, for example, serve the objective of price stability in the short run, it may in the end undermine the whole principle of price stability. Excessive fluctuations in interest rates, whatever their use in smoothing the rate of investment, may destroy the standing of bonds as a form of nonspeculative investment, and thereby affect the whole savings pattern of the country. Domestic instabilities of this sort, resulting from the overintensive use of certain instruments, can cause additional disturbances in the international field if they result in large fluctuations in countries’ reserves.

To understand the international problems, and the need for international cooperation that may derive from these problems, we must reformulate the national economic objectives in a manner more consonant with the way in which these objectives are evidently felt by the main countries:

(1) Each country would like to pursue its reasonable objectives with respect to prices, employment, and growth without being forced by the actions of others into an excessive use of its available instruments of economic policy. In regard to the objectives of price stability and employment, there appear to be rather wide margins of tolerance in at least some countries, which raise doubts as to how firmly these objectives are really held. Can we be sure that the maintenance so far of close to full employment in most of the industrial countries of Europe reflects an unflinching dedication to the full employment objective?

(2) Insofar as instruments are concerned, it is clear that there is a strong aversion toward too much use of any of them, and that this is an important fact of national and international economic life. The basic unwillingness to use instruments is clearest with respect to the exchange rate. In fact, a description of the economic policy aims of the industrial countries is simply incomplete or inaccurate if it does not put exchange rate stability high on the list of targets.

But the desire to avoid the use of instruments is not limited to the exchange rate. While in the long run the ratio of government expenditure or taxes to national income, or the structure and level of interest rates, can be changed a great deal, severe practical limitations and severe disadvantages attend an excessive use of these instruments in the short run. One of the most troublesome aspects of very intensive use of particular instruments is that, even if applied in general, the impact may be primarily on particular groups of the population or branches of industry. For example, the postwar fluctuations in interest rates in the United States, which were intended to stabilize over-all demand in response to cyclical fluctuations, produced some measure of over-all stability primarily by forcing on the residential construction industry a pattern opposite to (and slightly lagged to) that of the general investment cycle.6

(3) Equilibrium in the balance of payments cannot be treated as an objective of economic policy on the same basis as the targets mentioned under (1).

The balance of payments

To say that industrial countries since the end of the war have aimed at balance of payments equilibrium is surely not a true description of their behavior. Some countries that ended the war with negligible reserves (Germany, Italy, Japan) have aimed for a considerable period at balance of payments surpluses (just as some of the less developed countries that came out of the war with very large reserves have aimed at balance of payments deficits). Apart from that, many countries have in many years concentrated on their domestic objectives, provided they were satisfied that in doing so they would not get into balance of payments trouble. It was only in the few particular years when certain countries encountered payments difficulties which threatened to deplete their reserves that an improvement in the balance of payments became a direct objective of economic policy.

The general acceptance of the fixed exchange rate, and of consequential ups and downs in reserves, implies a rejection of balance of payments equilibrium as an objective of policy. It is far easier technically for a country to achieve a continuous balance in its payments than to maintain full employment or to keep the price level stable. The introduction of a fluctuating rate plus a decision not to intervene in the exchange market will automatically produce balance. Canada has kept its reserves practically constant in this way ever since 1951.

The memory of the difficulties of the immediate postwar period has naturally caused each country to place a high value on the safety assured by having adequate international liquidity and a strong balance of payments. But this does not raise balance of payments equilibrium to the rank of a target of national economic policy comparable with the targets, employment, growth, and price stability.

The use of reserves provides a country with its main opportunity for continuing to attain the targets of domestic economic policy in spite of shocks of both domestic and foreign origin. It is, of course, possible to think of a fairy-tale world in which, starting from a situation of international equilibrium with full employment and balance of payments equilibrium for all countries, everything continues to move in step and each country’s payments stay in continuous balance. This would involve such conditions as (1) continuous equality between the rate of change in wages and increases in productivity, (2) continuous demand from domestic private sources adequate to maintain full employment, or immediate government compensation for any deviations from this level, and (3) a stable pattern of international demand and supply.

Theoretically, the first of these conditions could be fulfilled if there were exact knowledge of increases in productivity, and a perfect wage policy to keep increases in wages in step with increases in productivity. Even if this were possible, one might question the desirability of jerky wage increases to match irregular improvements in national productivity. The second condition would imply the complete abolition of business cycles; there is no evidence that this is attainable. The third condition would be clearly undesirable in itself. As competition is so often defective within national boundaries, it is fortunate that a large measure of international competition continues. This must mean, dynamically, that producers in some countries invade the markets of others; that, at least temporarily, markets are lost and markets are gained. It also means that a world-wide market lies open to producers in individual countries for their new products, new techniques, new marketing schemes, and other such features. It would be a great loss if this dynamic aspect of international trade were eliminated, even if in this way one could achieve the sleepy state of balanced growth all around. Nor could one expect that the balance of payments effects of such dynamic forces in world trade could immediately be absorbed by frictionless price adjustments throughout the whole of the world economy.

Therefore, for the purpose of attaining a country’s price and employment objectives without making a disturbing use of its various instruments, the possibility of incurring a balance of payments deficit or surplus is of considerable value. Given the limitations on an excessive use of instruments, the fluctuations in the balance of payments provide the main opportunity for a country to pursue objectives that differ at least in some degree from developments abroad.

For example, if inflationary tendencies are prevalent abroad, leading to price increases, or to delayed deliveries of exports or excessive importing, any country that does not wish to participate in these inflationary policies will almost automatically accumulate a balance of payments surplus. The more successful the country is in insulating itself from the policies being pursued abroad, the larger will be that surplus. Similarly, if deflation prevails abroad, an individual country sticking to its price and employment objectives at home will inevitably incur a balance of payments deficit.

The balance of payments similarly absorbs, in part, the effects of autonomous changes of domestic origin. If inflationary or deflationary eruptions at home can readily be dispersed over the world market, their effects on domestic employment, prices, etc., will be minimized.

If the role of fluctuations in the balance of payments in the attainment of other economic objectives is considered, a certain similarity with the budget presents itself at once. When autonomous fluctuations hit the national economy, either from the outside or from the inside, the effect on gross national product (GNP) is likely to be the smaller, the more effective are the built-in stabilizers, such as a progressive income tax or unemployment compensation, etc. At the same time, the more effective these stabilizers are in stabilizing the economy, the more will they unbalance government finance. The role played by the balance of payments is in many respects parallel. In an economy without built-in stabilizers—where, to use the technical expression, the sum of all propensities to spend is unity—any disturbances coming from abroad will have only a temporary effect on the balance of payments. On the other hand, strong stabilizers will mitigate the impact of such disturbances on the economy while intensifying the balance of payments impact, in precisely the same manner as they intensify the impact on the budget.

It follows from this comparison that, in considering the whole array of economic policies, it is appropriate to take an attitude toward balance of payments disequilibrium that is in many respects similar to the attitude now generally accepted in economics toward imbalance in the budget.

On the one hand, in emergency situations, when the economy threatens to get out of hand, it is as proper to stress the imperative need of “equilibrium in the balance of payments” as it is to stress the need for a “balanced budget.” These, then, are not targets of economic policy, but rather very rough yardsticks of the government’s determination to bring the situation under control. What may often be needed in such situations will not in fact be equilibrium in the balance of payments, but a surplus to restore reserves and to repay amounts borrowed. As to the budget, what may be needed may again be a surplus, or in other circumstances a deficit of an order of magnitude compatible with available noninflationary sources of finance.

On the other hand, we must not lose sight of the valuable role that fluctuations in the balance of payments can play in helping to achieve a country’s main economic objectives, just as we accept the importance of contracyclical fluctuations in the government budget.

There are obvious limitations to the extent to which countries can resist, in their own economies, the tendencies prevailing abroad; and these limitations apply most severely to small countries in which foreign trade plays a very large role. When attempts are made to hold off deflationary developments abroad while maintaining a fixed rate of exchange, a natural limitation is set by the international liquidity, owned or borrowed, to which a country has access. Even in the reverse case, when the objective is to insulate the country from a prevailing inflationary fever abroad, there are limitations both to the willingness on the part of the country concerned to accumulate foreign assets rather than domestic investments, and to its ability to offset the inflationary effect on its economy of the inflow of reserves.

Therefore, a disequilibrium in the balance of payments cannot be expected to continue for any substantial length of time. Its function is to provide time to decide in which direction and by what means balance of payments equilibrium can most properly be restored in the somewhat longer run. If the disequilibrium is due to internal causes, it may be possible and proper to eliminate these causes. If it is due to external causes, these causes may be brought under control abroad within a moderate period of time. Resort to measures of a more general character, such as a change in the exchange rate, will be necessary only if the causes—abroad or at home—of disequilibrium persist over a period of time so long that there does not appear to be any justification for leaving the payments balance in disequilibrium.

The history of exchange rate stability over the past decade or more would appear to confirm the view that balance of payments fluctuations of a “fundamental” character are the exception rather than the rule. Since the basic pattern of the exchange rates for the industrial countries was set in September 1949, each industrial country has had to overcome severe balance of payments difficulties at least once. Going back into history one might mention, for example, the large deficits of the United States from 1958 to 1960, of France in 1957-58, of the Netherlands and Japan in 1957, Japan again in 1954, the United Kingdom in 1954-55, the Netherlands and Germany in late 1950 and early 1951. On almost all of these occasions, there were experts (as well as speculators) ready to jump to the conclusion that the currency of the country concerned was overvalued and that a change in the rate would be necessary to eliminate the deficit. However, except in France, the large deficits mentioned, and a number of others as well, were overcome without changes in par values. In a world economy in which most countries are running close to full employment and occasionally slip into overfull employment, balance of payments deficits have often proved to be reversible by little more than the disinflation of the excess demand—actual output receiving only a minor impact.

When production is bumping against the ceiling of total productive facilities, the balance of payments effect of small variations in demand tends to be very large proportionately, even in countries where the average ratio of imports to GNP is relatively small. The balance of payments effect of measures to damp down domestic activity may be particularly strong where the impact is, to a large extent, on inventories—particularly inventories of imported commodities.

It should be added that the balance of payments deficits that the industrial countries have experienced since the Marshall Plan ended, while sometimes large and frightening in terms of reserves, have in all cases been small in terms of GNP. The deficits expressed as a proportion of the country’s GNP in the relevant period are shown in Table 1 for a number of typical countries. In order to avoid the artificial reduction in the size of the problem that can arise from the use of annual data, quarterly statistics have been used to measure the length and the magnitude of the deficits.

Table 1.

Industrial Countries: Balance of Payments Deficits and Surpluses as Percentages of Gross National Product (GNP) 1

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Figures have been calculated from reserve movements (including IMF and EPU positions, and also, for the United States, short-term dollar liabilities and, for the United Kingdom, overseas sterling holdings).

The order of magnitude of all the deficits shown in the table lies between 1 and 3 per cent of GNP. These percentages were all smaller than the annual rates of growth in GNP of the countries concerned. Hence, if adequate flexibility of resources is assumed, it should have been possible to eliminate each deficit in less than a year by means of an improvement in the balance of goods and services, without any reduction in the national product available for domestic use. Table 2 shows that in most of the countries this was what happened.

Table 2.

Industrial Countries: Changes in Real Gross National Product (GNP) and Its Components in Years of Balance of Payments Deficits and Years Following

(As percentages of GNP in the first-mentioned years)

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Sources: For European countries, Organization for European Economic Cooperation, Statistical Bulletins: General Statistics, January 1961; for Japan, Economic Planning Agency, White Paper on National Income (in Japanese, Tokyo, February 1960); for the United States, Economic Indicators (Washington), July 1961.

Seasonally adjusted annual rates for the second quarter. Since data on expenditures on GNP at constant prices are not available for 1961, the implicit price deflator for total GNP was used to deflate the various components.

It may be mentioned in passing that the two tables approach the balance of payments from slightly different angles. Table 1 measures the deficit in the balance of payments as a whole, including capital movements except reserve items; Table 2, on the other hand, measures the improvement in the balance of payments in the goods and services accounts only. The first approach is the correct one if the desire is to focus attention on the balance of payments difficulties that governments have to face: in this connection, deficits on capital account are as important as those on goods and services account. The second approach is more appropriate when investigating the extent to which the measures taken to restore balance of payments equilibrium have had a real influence on the economy.

For all countries except Norway, Table 2 shows an improvement in the goods and services account in the year following the payments deficit. (For the United States, a shorter and somewhat later period of comparison was taken, which corresponded better cyclically with the year of the largest deficit, 1959.) The improvement in net exports varied in magnitude from slightly under 1 per cent of GNP (United Kingdom in 1956 and United States in 1961) to a little more than 3 per cent of GNP, with the one exception of the Netherlands in 1958, which showed an improvement of 6.7 per cent of GNP. This last figure, which was attributable to the consequences of corrective policies coinciding with those of a cyclical downturn, led to a large overcorrection of the 1957 deficit. The sharp reversal in the goods and services account was also larger than could be absorbed by the small increase in real GNP in a year of recession (1.5 per cent). Although there was also a sharp reversal in the accumulation of inventories (—2.4 per cent of GNP), the share of production available for domestic consumption and investment in fixed assets was nearly 3 per cent smaller in 1958 than it had been in 1957. As the table shows, the experience of the Netherlands was not typical for the balance of payments adjustment in the industrial countries. The real product available for domestic use increased everywhere else except in Denmark (1955). In spite of the fact that more resources had to be applied to reinforce the balance of payments, the increase in production, together with a reversal in inventory developments which occurred in almost all countries, made available sufficiently large real resources to enable adjustment to be achieved in this comparatively painless way. The figures indicate that real “sacrifices” in order to attain balance in international payments constituted the exception, not the rule.

On the whole, the record for surpluses is very similar to that for deficits. The large surplus of the United Kingdom in 1950 disappeared in a very short time. The large surplus of France in 1954-55 was the precursor of an even larger deficit in subsequent years. The surplus of the United States in 1957, the Indian summer of the “dollar shortage,” had disappeared before the end of that year. The large surplus of Japan in 1959-60 had run its course by mid-1961. In the whole postwar period, there appears to have been only one unmistakably intractable surplus—namely, that of Germany since 1952; that of the Netherlands represents a less clear-cut case.

The broad experience of the industrial countries in the postwar period indicates that it has been possible to reverse balance of payments disequilibria by means of fiscal and monetary policies of moderate impact, and to avoid causing deflation in the deficit countries. Such policies would, of course, not be sufficient to bring about balance in situations where relative price levels had moved seriously out of line. In such situations, exchange rate adjustments would also be necessary, as occurred in France.

The importance of keeping prices and costs in line internationally as a means of avoiding balance of payments disequilibria cannot be denied. But it is surely going too far to infer from the fact that deflation has not been necessary (and would not be accepted) that “the only policy which remains available as a means of restoring equilibrium is one which aims at producing a differential trend of national cost levels as between the deficit and the surplus countries, so that by this means the former may improve their possibilities of selling abroad by comparison with the latter.”7 The budget policy in the United States in 1959-60 and the fiscal and credit measures announced in the summer of 1961 in the United Kingdom—to give only two examples— hardly seem to justify attributing to wage policy so unique a role in restoring international balance.

II. International Action

Having discussed the national and the international compatibility of targets and instruments, we may consider measures of an international nature—”rules of the game,” guidelines, coordination, action by international agencies, etc.—that will assist countries to attain their national policy objectives in an international setting.

The theory of the international coordination of national action has been worked out by Professor Tinbergen.8 Starting from a set of national policy models, he necessarily comes to the conclusion that all economic instruments except those that are “neutral” (i.e., that have no important economic effects abroad) should be centralized internationally.9 The reasoning behind this conclusion is simply that centralization allows all the effects of particular actions to be taken into account, while decentralization leads policymakers to take into account only the effects within the region for which they are responsible. Professor S. Posthuma comes to essentially the same conclusion.10

These conclusions appear to me to be open to question on both theoretical and practical grounds.

(1) The first observation to be made is that the interest of other countries is not related to individual measures taken, but to the net effect of the totality of these measures. Except insofar as some specific instrument might have a particularly disturbing effect abroad, the rest of the world has no overwhelming interest in the manner in which a country brings inflationary pressures under control—whether it raises taxes, cuts expenditure, tightens bank credit, restricts consumer credit, limits construction, or uses any combination of these and other means.

(2) International coordination of the use of instruments is not feasible in a situation where neither countries as such nor their governments have clear views as to what their preferences are, and where governments may not care to set up the machinery to distill a joint view on these matters from whatever may be the vague and probably contradictory views of the people. In such a situation, national policies may be made without a clear attitude toward certain main targets; such policies do not admit of international centralization of the type envisaged in Tinbergen’s models.

In general, there is no point in advocating the international coordination of policies that cannot be implemented nationally, or that perhaps—in the sense of our analysis—do not even exist in many countries. The fact that a country has an annual budget does not ensure that it uses “fiscal policy” to achieve particular economic aims. Expenditure may be affected from one year to the next by merely impelling requirements of defense or social policy; tax rates, by the imminence of an election.

In this connection, it is perhaps appropriate to note that few other industrial countries are as fully committed to economic policy in this sense as is the Netherlands. There is, for example, no other industrial country with the full equivalent of the Netherlands Plan Bureau.

(3) Nor is there an unlimited need for the coordination of action. As indicated in Section I, the industrial countries have sufficient policy tools, including in extremis the exchange rate, to enable them, if necessary, to dissociate to some extent the course of events in their own economies from what happens abroad.11 While the pursuit of proper policies abroad is important for them, they are not fully at the mercy of any improper policies that foreign countries, even major economic powers, may indulge in. Whatever complaints one may have about the postwar economic policies of the United States, the United Kingdom, Germany, or France, it would appear that these policies account very little for the setbacks that such countries as the Netherlands, Sweden, or Austria have experienced. With a possible qualification for short-term capital movements, it is fair to say that, wherever in recent years things have gone wrong in an industrial country, the reason has been not a failure in the world economy but a deficiency of domestic policies. Perhaps we should make allowance for the fact that the postwar world has not been put to the test of a deflation of the severity of the interwar period, nor to that of a virulent inflation. But even in the thirties there were some countries that, by an appropriate use of monetary and exchange rate policies, did not suffer greatly or long from the deflation of that period.

Moreover, the events in large countries which do influence small ones are often not specific decisions of economic policy, on which consultation might have been possible, but much broader decisions on which such consultation cannot even be envisaged in present conditions. The outcome of the presidential elections in the United States, major decisions to stimulate agricultural or nuclear research, proposals such as that of the Marshall Plan or the Alliance for Progress, can be far more important economically for the rest of the world than, say, a complete round of tariff negotiations.

When we consider the field of international action, it is important to distinguish between arrangements on specific subjects and more general willingness to cooperate and harmonize national policies internationally.

International action on specific economic policies

Analysis of experience with the international coordination of specific policy actions would appear to indicate that this coordination was most successful where certain conditions were fulfilled: in particular, (1) where the countries concerned had committed themselves to observe certain rules; (2) where this obligation was specific in nature, providing an objective test as to whether and to what extent the promised action had been taken; (3) where the commitment referred to concrete governmental measures, rather than to the more uncertain effects of such measures; and (4) where the effect on other countries was obvious and specific, whether it was large or small.

A discussion of certain examples of successes and failures in economic policy coordination may help to make these points clear.

Exchange rates

The exchange rate is the prime example of an economic policy variable which fulfills the four conditions for successful coordination.

The principle of fixed exchange rates incorporated in the Articles of Agreement of the International Monetary Fund has its origin in fears that countries would devalue or depreciate their currencies without due cause; the avoidance of “competitive exchange depreciation” was specifically written into the Articles as a “purpose” of the Fund.

In the present context, it is immaterial that the Fund’s responsibility for exchange rates in the postwar period has hardly called for the protection of members against unjustified depreciations of the currencies of other members. Overwhelmingly, the Fund’s action has had to be aimed at stubborn overvaluation, rather than undervaluation, of currencies. As a consequence, the heavy artillery assembled in the Fund, including the right to deny members the use of its resources, has had to be wheeled around 180 degrees before it could be used. Moreover, since overvaluation does not directly hurt the trade or employment of other countries, the Fund’s action in persuading countries to reduce overvalued rates has served to help the countries that have ultimately accepted the much needed devaluations, rather than to protect the interests of other countries against unfair devaluations.

There are obvious difficulties in the effective discharge, by an international agency, of an approving jurisdiction with respect to instruments of policy that have to be prepared by a country in secret and must be introduced with a minimum of delay. The solution to these difficulties—insofar as there is a solution—lies essentially in close cooperation between member countries and the staff of the international agency. Whatever may be the extent to which the Fund has been able to master this technical problem, there can be no doubt that it is generally accepted that exchange rate changes are internationalized and have to meet the test of being “necessary to correct a fundamental disequilibrium” before countries propose such changes to the Fund.

To make policy coordination possible, it is important that there should be a fixed exchange rate, adjustable by a specific amount. In those countries which have, as a transitional measure, adopted a fluctuating exchange rate, the coordination of changes in those rates is more difficult, partly because the point at which consultation is called for loses its precision and partly because of the lack of clarity as to the government’s responsibility for a rate that is allowed to be determined by “market forces.”

Tariffs, quantitative restrictions, internal revenue duties

The General Agreement on Tariffs and Trade (GATT) has been successful in reducing tariffs, and the Organization for European Economic Cooperation (OEEC) in reducing quantitative restrictions, first on trade among its members and later on a nondiscriminatory basis. Here again, the four conditions for success mentioned above were fulfilled.

Moreover, the strength of the commitments for eliminating quantitative restrictions was increased greatly, and a somewhat artificial, but helpful, precision was introduced, by the adoption of the concept of liberalization percentages and the acceptance of agreed targets for these percentages.

In this field, the importance for successful coordination of the existence of a prior governmental commitment is clear from the failure to coordinate internal revenue duties. Such duties, levied by many countries on imported commodities, like coffee, tea, tobacco, etc., are in no sense different, in their external and internal impact, from customs duties. They were so treated by the Havana charter of the International Trade Organization (Interpretative Note to Article 17). The relevant section of the GATT did not, however, embody this interpretative note. As a consequence, “… the international efforts made in the last few years to lower trade barriers have failed to result in a substantial alleviation of revenue duties. … As internal taxes are not at the present time deemed to be negotiable in the same way as ordinary customs duties, a number of importing countries have declined to enter into negotiations for the reduction of revenue duties.”12

Full employment

We have so far discussed international coordination with reference to a number of instruments of economic policy. We now turn attention to a target of policy, on which there is an international commitment.

“Full employment” is one of the three objectives in the economic field which the United Nations, by Article 55 of the Charter, has undertaken to promote.13 Since all members of the United Nations pledge themselves, in Article 56 of the Charter, to take action for the achievement of the purposes stipulated in Article 55, it is not unreasonable to speak of a full employment pledge which the members have undertaken.

The attitude on employment expressed in the UN Charter was, of course, similar to that of its major members. In the U.S. Senate, for example, a Full Employment Bill had been introduced early in 1945 which led to the passing, about a year later, of the Employment Act of 1946, with a significant loss of the adjective during the year. The text of the Act called for “maximum employment, production, and purchasing power.” There are also similar provisions in the Fund and GATT charters.

In its early years, the United Nations set out to enforce the full employment pledge. The Economic and Social Council (ECOSOC), the body in the United Nations that is responsible for economic matters, at once established an Economic and Employment Commission to advise the Council on “the promotion of full employment by the coordination of national full employment policies, and by international action.” This Commission in turn established a Subcommission on Employment and Economic Stability to keep a sharp eye on the developing situation and to report suggestions for national and international measures to its parent and its grandparent bodies.

To pursue the same objective, the UN Secretary-General subsequently brought in a group of outside experts. Their report, National and International Measures for Full Employment, published in December 1949, represents the high point in the pursuit of the full employment objective within the framework of the United Nations. The experts recommended that UN member countries give substance to their full employment pledge by announcing (1) what, in their respective countries, should be considered the full employment target, and (2) a system of measures to expand effective demand, to come into operation automatically as soon as employment fell significantly below the full employment target.

While ECOSOC did not adopt the specific proposals put forward by these experts, it decided to hold annual full employment discussions at which countries would be asked both to state their objectives with respect to employment, production, etc., and to announce their policies to deal with these matters. Early in 1950, it looked clearly as if the moral pressure of ECOSOC was going to be marshalled to keep countries to their full employment pledge.

It is no exaggeration to say that nothing came of this. The Commission and the Subcommission were abolished as ineffective. ECOSOC debates covered “full employment”; but the debates on the subject proved entirely sterile. Significantly, the subject of full employment, so hopefully introduced in 1950, was dropped from the agenda by 1954, being absorbed in the general review of the world economic situation. This review became increasingly a general statement of national policies on broad issues, without the urgency and timeliness that would be an essential condition for any discussion aiming (as had been the hope in the early UN years) at quick action to deal with situations that might spell danger to employment.

In part, one can attribute this failure14 to the success of national employment policies during the fifties. But this success was not perfect: recessions occurred, and the fear of deep depressions had not been banished. A large part of the failure to achieve a method of enforcing the “full employment pledge” would seem to be due to the nature of that pledge. There is such a strong national commitment to something close to “full” employment that each country acting for itself at any moment of time moves as closely to this objective as it considers possible. In deciding what is possible, it has to make compromises with the other objectives of economic and social policy, such as the desire to maintain price stability, the desire to protect the balance of payments, the willingness to accept some measure of control over wages, and similar competing desiderata. After the proper (or, if one prefers, the feasible) national compromise of objectives, in which a very high priority is given to the employment target, has been reached, there is virtually no “give” left, and nothing can really be achieved by urging or pushing from abroad. If the compromise involves a relatively high rate of unemployment, the social cost of that situation clearly falls far more heavily on the country itself than on its trading partners; and if the country has already decided not to reflate, or not to reflate more, in spite of the pressure from its unemployed and from its business, there would seem to be no reason why it should be willing to do so under pressure from foreign countries.

International coordination of other economic policies

The examples that we have been discussing of the coordination of policies provide some guidance as to the direction in which additional efforts might properly be directed.

Price stability

The experience with respect to the UN full employment pledge suggests skepticism as to the advisability of coordinating price policies by means of internationally set targets, not to be exceeded. While it is generally agreed that “full” employment does not mean 100 per cent employment, price stability in the target sense must obviously mean a 0 per cent increase in an appropriate price index, even though the imperfect attainment of this target could be accepted occasionally. The arbitrariness of the index, the multiplicity of causes of price changes (both domestic and foreign, official and market), as well as the need for all governments to balance the importance of driving toward one target against the achievement of other targets, make it clear that national policies to achieve stability would be little aided by the introduction of an international obligation.

Wage policy

In present circumstances, the need for, or the possibility of, coordinating national wage policies seems as slim as it does for price policies, if for no other reason than that the elementary condition, viz., the existence of national wage policies, is not fulfilled.15

In other conditions—like some that we have experienced in the past but which we trust will never return—there might, however, be a great need for coordination of wage policies. In the present climate of massive wage increases, it is perhaps hard to recall that, in the early thirties, countries were actively engaged in competitive wage reductions on a massive scale. The following somewhat abbreviated quotation from a highly competent contemporary source may serve to refresh memories:

Towards the end of 1930, the whole wage situation in many countries began to be seriously affected by budgetary difficulties…. The first important country to embark on a considered and radical scheme of deflation was Italy. In November 1930, salaries and allowances were cut 12 per cent. At the same time, an extensive campaign of propaganda was aimed at a general wage reduction of approximately 10 per cent….

In the middle of 1931, many other countries followed this line of action…. The [Australian] Commonwealth Arbitration Court … on March 30th, 1931, … delivered final judgment which reduced the “real” basic wages of almost all workers under its jurisdiction by an average of 10 per cent. … In addition … a continuous fall in the cost of living lowered nominal wages still further for those workers subject to the Commonwealth Arbitration Court. By October 1931, the total reduction approximated 23 per cent….

The New Zealand Arbitration Court had reduced wages by 10 per cent on June 1st, 1931. In March of the following year, a scheme of retrenchment in some respects like that of Australia was introduced, together with a further wage and salary cut of 10 per cent….

In Germany, … the Government’s defence against devaluation of the currency took the form of the drastic and unprecedented measures contained in the fourth Emergency Decree of December 8th, 1931…. The general principle of wage reduction was to get back to the level of January 10th, 1927, provided the change did not involve more than a 10 per cent cut, the object being to get rid of the increases which occurred in the period of credit expansion 1925-9. As a total result of these various steps, the general index of wages in Germany has fallen from 107 in 1930 to 90 at the beginning of 1932….

It was not till the latter part of 1931 that deflation in Italy, Germany and the United States and devaluation in Great Britain threatened to cause an international competition in lowering costs of production….

In the first half of 1932, the movement for wage reduction gathered force. A substantial proportion both of the industrial and of the agricultural countries had removed the immediate pressure on their wages and price systems by going off gold. The annual wage contracts made in Europe in the spring of 1932 felt the pressure and reductions were inevitable. Both in agricultural and in industrial industries, wages fell.16

Interest rate policy

Each industrial country has one important interest rate, the discount rate of the central bank, that is set from time to time by official action.17 While the influence of the discount rate on the general pattern of interest rates differs from country to country, the discount rate is everywhere important to international capital movements. By the criteria suggested earlier, interest rates would seem to provide an area where international cooperation would be possible and could be profitable.

The international significance of interest rates has re-emerged with considerable suddenness. In the early postwar years, interest rates were little used to deal with cyclical problems (or at least their use was limited to relatively moderate swings); and even when a more intensive use of them began to be made, its international impact was minimal as long as capital movements were severely controlled, currencies were inconvertible, and only the dollar had the status of a first-rate currency. These conditions have only recently disappeared, say in 1959 and the early part of 1960. The emergence of large-scale capital movements dominated by interest rate differentials is a phenomenon of, at most, the last two years. But these movements bring home the facts that interest rates, like exchange rates, may have competitive international connotations; and that in certain circumstances unrestricted national interest rate policies may have balance of payments effects—and even, in the absence of adequate reserves, employment effects—as serious as unrestrained exchange rate policies.

Neither the most appropriate manner in which to deal with this new phenomenon nor the role of international interest rate policy in this connection has yet emerged clearly. There has been little tendency to meet the problem by intensifying controls on capital movements. However, in spite of the general movements toward freer trade and capital movements and the full convertibility of currencies, many European countries still have substantial controls over the outward movement of capital. In addition, some attempts have recently been made in Germany and Switzerland, though not very successfully, to block the inflow of capital by control measures. As a further discouragement to short-term capital inflows, some attempt has also been made, particularly by Germany, following techniques that had been developed over many years, to increase the profitability of short-term capital exports at given interest rate differentials, by official intervention in the forward exchange market.18

The adoption of some form of international interest rate policy would require a prior clarification of its objectives. On the one hand, the aim of such a policy can be seen to ensure that national interest rates are sufficiently different; on the other hand, that they are sufficiently alike.

The first point of view has been forcefully expressed in a presentation by Mr. E. M. Bernstein:

… it would be a serious mistake to attempt to secure through the Fund, or by agreement outside the Fund, a pattern of relative interest rates in the great financial centers primarily designed to minimize the international flow of short-term funds. Interest rates in each country should be suited to its own conditions: In the short run, to the cyclical forces operating on its level of economic activity; and in the long run, to its relative international economic position and its relative capacity to supply savings for investment at home and abroad. Some average interest rate for short-term or long-term credit, common or nearly common to all the great financial centers, would be a rate suited to none. If interest rates appropriate to the needs of each country induce large capital movements, the way to deal with them is through supplementary reserves provided by a reserve settlement account.19

The greater freedom and willingness of capital to move has, however, reduced the scope for interest rate policy, and for monetary policy in general, as an instrument of internal economic policy. When the pressure of domestic demand is high, the main effect of raising interest rates may be to draw in additional finance from abroad; when the economy is slack, a lowering of rates may primarily result in money moving out of the country. If, in these circumstances, interest rates in different countries are set so far apart as to induce large-scale capital movements, they tend to frustrate the internal objectives which they were expected to help to achieve: tightness of capital in the boom and ease in the recession. Whatever the balance of payments conditions of the countries concerned, and whether they can conveniently be financed or not, these capital movements are undesirable from the point of view of the internal policies pursued. This point had long been appreciated in such countries as Switzerland and the Netherlands, which kept their discount rates at the relatively low levels of 2 per cent and 3½ per cent, respectively, throughout 1960, despite strong internal demands for credit. Germany, after the experience of raising the discount rate in the summer of 1960, fell back on a similar line of policy later in the year and early in 1961.

A helpful perspective on this issue can be acquired by realizing that the process of financial integration through which the money markets of the industrial countries are now going is similar in nature to that experienced in the last decades within the United States:

The founders of the Federal Reserve System contemplated that Reserve Bank discount rates would be set in accordance with regional financial conditions. They expected that variations in regional conditions would lead to variations in discount rates among the Reserve Banks. In recent decades, however, rates have tended to be uniform, although there have been temporary periods in which different rates have obtained. Basically, this tendency toward uniformity reflects improvements in the facilities and speed of communication and transport as well as further geographical integration of industrial, commercial, and financial enterprise.

Credit is a fluid resource that tends to flow to the market of highest yield. Growth in the number and assets of regional and national enterprises that are capable of meeting their financing needs readily in the cheapest market has increased the mobility of demand for funds. Furthermore, the highly sensitive central money markets, that is, the markets for Treasury bills and other short-term instruments, have provided a mechanism through which the forces of fluid supply and mobile demand are promptly registered. Thus, the regional credit and money markets have really become only segments of a closely knit national market, and this fact has found expression in a tendency toward uniformity of discount rates among the Reserve Banks.20

In the United States, this process of unification has gone so far that it has become, in economic terms, practically meaningless for any Federal Reserve Bank to have a discount rate different from that of other Reserve Banks. The problem before the Board of Governors is not, therefore, to authorize an “appropriate” rate for each region, depending on that region’s economic conditions, but to reach agreement on a uniform rate for the country as a whole in spite of differences in regional conditions. These issues, together with other issues of monetary policy, are thrashed out in the Federal Open Market Committee, in which five of the twelve Federal Reserve Banks are officially represented, but in which the presidents of all twelve Reserve Banks participate as a consequence of a recent innovation intended to obtain a full representation of all regional conditions.21

Among separate monetary units, somewhat more room for independent interest rate fluctuations is likely to persist than is feasible within the United States. Nevertheless, the main function of the international coordination of interest rate policies, as it appears to be shaping up, may be not so much to persuade countries to bring their interest rates into line—this the market may do to a considerable extent, whatever may be the desires of countries—as to find a method by which national views can be taken into account in the effective determination of the general interest rate pattern in all industrial countries.

The preceding survey of international economic coordination, actual and contemplated, suggests a measure of success, and room for progress, with regard to the more concrete instruments of policy. For the broader policy objectives, however, there is little reason to believe that the national pursuit of the employment and price objectives would be much helped by numerical international commitments on these subjects. In answer to the specific questions put before the discussants, therefore, I would conclude that there would be little merit in attempting to agree on concrete norms for the national equilibrium objectives, or to specify margins of tolerance for them.

International cooperation of a general character

Beyond specific arrangements of the types that we have been discussing, there is a broad field in which effective international cooperation on economic policies can be beneficial from a national as well as from an international point of view.

As a first step toward such cooperation, it is necessary to have adequate information about the facts and the intentions of countries. Unless countries know each other’s economies, and the motivations, objectives, and difficulties of each other’s economic policies, they cannot even begin to think of coordinating their policies, nor can they play a constructive role in the actions of international agencies. Here, knowledge by “countries” means knowledge by a large number of individuals: cabinet members, central bank governors, civil servants, members of legislative bodies, bankers, trade unionists, journalists, and many others.

The systematic collection of this knowledge is particularly useful when it is directly linked to the performance of the functions of international agencies. I may mention in this connection the GATT consultations and countries’ annual consultations with the Fund, under Article XIV, regarding the maintenance of exchange restrictions. The consultations which the Fund has recently begun with members not under the transitional postwar regime of Article XIV extend the Fund’s consultations to its full membership. These consultations help the Fund to exercise its other functions, such as the approval of proposals for exchange rate changes and the granting of balance of payments assistance.

Consultations of this nature help international agencies to achieve their objectives over time, because continuous contact with their member countries enables them to have an influence on policies in their formative stage before they have been frozen into “official positions.” The establishment of close and confidential relations between governments and the permanent staff of the agencies, fully aware of the problems of each member country, is a most important part of this process of gradual harmonization of national policies.

In addition to its role in connection with international action along lines already agreed, such intensive and continuous consultation serves to make possible appropriate international action when new needs emerge. It helps to make countries more aware of the possible effects on other countries of their own action, and it is of course essential as a preparation for an ultimate merger of certain national policy actions by entrusting them to international organs, such as might be formed under the European Economic Community (EEC).

From this sketchy treatment of the subject of international policy coordination it should not be inferred that all that goes on internationally represents policy coordination. International conferences, standing committees, bilateral discussions, unofficial visits, secretariat activities, economic reports, expert missions, often have as their only purpose, and even more often as their only achievement, to inform and to clarify. A country’s actions are explained by its own officials or analyzed by an international staff or an international board; or its methods of handling particular technical questions—like exchange control or credit restrictions—are discussed against the background of national peculiarities and experience elsewhere. Assessments may also be made of the general outlook for a country’s economy, or of the likelihood that particular measures will achieve the results hoped from them, without any action, or any effect on national policies, necessarily following.

While it is a long and difficult process to achieve some measure of international influence on national policies, it is exceedingly easy to extend international activity of an informational nature. It can be extended to cover additional subjects with unlimited room for specialization. It can be expanded almost at will regionally, in the framework of such organizations as Benelux, the EEC, the Western European Union, the Organization for Economic Cooperation and Development, or the membership of the Economic Commission for Europe, and in different forums internationally in the UN Assembly, ECOSOC, the Fund, the GATT, and in other bodies. Within each of these, matters can be discussed at various levels—for instance, the ministerial, sub-ministerial, or expert level; and against most of the possible cross-classifications there are possibilities of technical assistance, training programs, statistical work, or research projects.

III. The International Monetary System

In Section I we discussed the ambivalence of balance of payments disequilibria. On the one hand, such disequilibria can be helpful, in that they permit countries to pursue national objectives with at least a certain degree of independence from developments abroad; on the other hand, disequilibria must not be allowed to persist for so long, or to such an extent, that only drastic adjustments can bring countries back into line.

The ability of a country to incur a balance of payments deficit is limited by the size of its reserves and of the other international liquidity to which it has access. In the present international monetary system, international action with respect to a country’s liquidity revolves around a country’s ability to draw on the Fund. The conditions attached to the use of this component of international liquidity reflect the two opposing considerations with respect to a balance of payments deficit. On the one hand, the Fund’s resources provide countries, according to the Fund’s purposes, “with the opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.” On the other hand, the same provision enjoins the Fund to see to it that its resources are made available “under adequate safeguards,” in order that the time bought by using the Fund’s resources is not wasted, but used by the country to make the adjustments that may be necessary.

There is thus a direct connection between the Fund as a provider of additional resources and the Fund as an instrument of international monetary discipline. In this manner, the Fund system provides an adaptation of the gold standard mechanism to the requirements of the present situation. As put by the Fund’s Managing Director:

Through assistance from the Fund, an additional source of credit is available to any member government that can satisfy the Fund of its intention and capacity to restore balance in its monetary affairs. The Fund can therefore in this way play an essential part in maintaining monetary discipline and balance, comparable to the way the old gold standard maintained balance before the First World War; but the Fund also supplies a measure of credit by which the harshness of the old rules is somewhat mitigated.22

The proportion of their total international liquidity that countries hold in the form of their drawing potential in the Fund has risen substantially in recent years.23 It now amounts to about $17 billion, a figure that may be compared with total official foreign exchange reserves of about $22 billion and gold holdings of about $38 billion.

The Fund has always adhered to the principles that use of the Fund should be temporary, and that the larger the extent to which (measured against the member’s quota) a country desires to use the Fund’s resources, the stronger needs to be its justification. But the precise meaning of “temporary use,” and the measure of justification necessary before a member can avail itself of particular portions of its quota in the Fund, have been subject to change in the light of prevailing circumstances. In 1952, for example, the Fund defined temporary use as use not exceeding three to five years, whereas previously the implication of the Fund’s scale of interest charges had been that temporary use could extend somewhat longer. To give another example, it was not until 1953 that the Fund used for the first time a provision (which it has since used very frequently) allowing it to waive the limitation on drawings to 25 per cent of a country’s quota within any twelve-month period, imposed by Article V, Section 3 (a) (iii). In 1961, the Fund approved for the first time a combined drawing and stand-by arrangement that enabled a member to use the Fund’s resources to an amount in excess of 100 per cent of its quota. These policy changes can easily be identified. It would in the nature of things be far more difficult to say when the Fund made changes in the degree of performance toward stability that it expected from a member before permitting it to draw relatively large proportions of its quota.

The “rules of the game” which the Fund may thus be said to apply in its policy governing drawings do not have the precision that is so often romantically attributed to the “automatic” gold standard.24 Whatever some may recall of the merits of that standard (and whatever others may have forgotten about its demerits), it would seem clear that any more precise definition of a country’s general commitment with respect to its balance of payments, or with respect to the internal conditions leading up to its balance of payments, is out of the question in present circumstances. The flexibility inherent in a mechanism administered by the Fund corresponds to the flexibility on which countries insist nationally in managing their own currencies. Managed currencies can be managed well or badly, both nationally and internationally; the quality of the results of an “automatic” system is not guaranteed either.

The international monetary system as it operates at present cannot deal as conveniently with excessive surpluses as with excessive deficits. Surplus countries have no need to come to the Fund and are, therefore, under no pressure to adjust their policies in order to qualify to use the Fund’s resources. Nevertheless, the powers of the Fund are broad enough to influence surplus countries as well as deficit countries. In addition to the two purposes mentioned on page 175—those dealing with exchange stability and with the provision of resources—the Fund’s purposes also include the promotion of international monetary cooperation, the facilitation of the expansion and balanced growth of world trade, and the reduction of the degree of disequilibrium in international payments.25 In virtue of these very broad purposes, it is natural that the gathering, for a full week, of Ministers of Finance and Presidents of Central Banks at the Fund’s Annual Meetings has become the outstanding occasion for top level pressure for international adjustment, when needed, to be applied. The Articles of Agreement of the Fund provide, moreover, a specific means of pressure on surplus countries through the scarce currency provisions of Article VII. There is no experience available on the basis of which one could predict whether the application of that provision, or its serious consideration by the Fund, could not be a powerful agent toward inducing a member to change its policies in a way desired by the Fund.

While, under the present international monetary system, the Fund has substantial power to induce countries to keep in line with each other, it does not follow that this, or any other, international monetary system is particularly powerful in holding the line itself. A general inflationary movement or a general deflationary movement will not necessarily produce serious balance of payments disequilibria, as long as all countries, broadly speaking, inflate jointly or deflate jointly. The extent to which the Fund’s resources are called into action depends more on differences in national developments than on the general trend of world developments. These differences can arise as easily in one phase of the cycle as another. In the early years of the Fund, it was generally anticipated that the Fund’s transactions would be largest when there was a depression in the United States. However, the Fund’s experience has been that, during the last decade, apart from two large transactions with the United Kingdom, the demand for the Fund’s resources was most active in 1956-57, when the U.S. economy was at the top of its weak cycle but when expansionary forces in the other industrial countries were far more pronounced.

It follows that policies concerned with international liquidity can, only to a limited extent, come to grips with strong and widespread contractionary or expansionary tendencies in the world economy. There is, therefore, little ground either for the fears or for the hopes that are often expressed in this regard. The world economy is not likely to crumble for lack of international liquidity, nor to soar into inflation because of an overabundance of liquidity. But the converse of these propositions is also true: if inflation were to take hold again, there is little that action on international liquidity could do to brake the undesired expansion in the value of world trade; and while an expansion of international liquidity (for example, by a very great relaxation of Fund policies) could, it is true, mitigate somewhat the intensity of any world deflationary trend, it would not nip it in the bud. The primary responsibility for keeping the world economy on an even keel inevitably rests with the main industrial countries; the regulation of international liquidity could help only to a limited extent to stave off the consequences of any failure on the part of these countries to perform this task.

APPENDIX: Objectives and Instruments

Is it possible for all countries at the same time to achieve three specific objectives of their economic policy: full employment, price stability, and balance of payments equilibrium? From an international point of view, the answer to this question is in the affirmative. This can easily be demonstrated by generalizing for a group of N countries an economic policy model of the type developed by Tinbergen for individual countries.

Let us assume that these N countries have N price objectives (stability for each), N employment objectives (full), and N balance of payments objectives (equilibrium). This yields a total of (3N-1) purposes—one less than 3N because balance of payments equilibrium for N-1 countries implies that the Nth country is also in equilibrium. To achieve these (3N-1) objectives we need, according to Tinbergen, (3N-1) instruments. Among N countries, there are in the first place (N-1) independent rates of exchange.26 If every country has two other instruments at its disposal, for example, in its interest rate policy and in its public finance, we have the requisite (3N-1) instruments.

Note that this conclusion is in no way dependent on the assumption that each country aims at stability of prices, full employment, or equilibrium in its balance of payments. The instruments that we have enumerated are sufficient to achieve any assortment of (3N-1) objectives that the N countries individually want to achieve, with only one exception: in order that (N-1) countries can freely pursue the balance of payments positions that they desire, there must be one country without a balance of payments objective of its own—one that is prepared to accept a deficit in its payments equal to the net surplus of all other countries, or a surplus equal to the net deficit of all other countries. 27 It would not be unreasonable to say that the United States assumed this role during the fifties.

The conclusion that a world of N countries can pursue any combination of (3N-1) objectives implies at the same time that (with the one exception noted) each country can achieve its own three objectives with the instruments at its disposal, independently of actions of other countries.

It is appropriate to mention two technical reservations with respect to the mathematical model implied in the preceding. It must be recognized in the first place that it is not certain that the (3N-1) equations are of such a nature as to be able to yield in fact the desired values for the (3N-1) objectives; (3N-1) instruments are necessary, but not always sufficient, to achieve (3N-1) objectives. Without wanting to enter into a complete analysis of this question, it would appear, nevertheless, that this reservation is only formal in character as long as the instruments include (N-1) rates of exchange or equally flexible variables.

A second question of great importance would arise if it were true that countries did, in general, try to achieve their desired position in the world economy by means of flexible rates of exchange (or flexible price levels). In that event, it would be important to determine whether the system sketched could be considered stable. This question has received remarkably little attention in the literature; 28 and this is perhaps the best proof of the fact that the formal problem dealt with in this Appendix, with its sharp distinction between objectives and instruments, does not truly fit the international economic policies of the majority of countries.


Le présent article a été préparé pour une réunion de la Société économique des Pays Bas du 9 Décembre 1961. Il est fondé sur la liste des problèmes à étudier (reproduite page 149) qui établit une distinction très nette entre un certain nombre d’objectifs déterminés de la politique économique et les moyens disponibles pour les réaliser. Tout en étant utile pour l’étude de certains problèmes, une telle distinction comporte des inconvénients sensibles dans le cadre actuel. La nécessité d’une coordination des mesures à l’échelon international est due moins à des différences entre les objectifs nationaux qu’au désir des pays de limiter la nécessité d’utiliser divers instruments de la politique économique. A ce propos, l’attention se concentre particulièrement sur le taux de change et le déséquilibre de la balance des paiements: la stabilité du taux de change est généralement reconnue comme étant un important objectif intermédiaire, alors que la possibilité d’un déficit on d’un excédent temporaire dans la balance des paiements constitue un moyen précieux de réaliser les objectifs nationaux de prix et d’emploi dans un monde soumis à une évolution dynamique. Au cours des dix dernières années les pays industriels ont en général été capables de renverser les déséquilibres de leur balances des paiements sans s’écarter trop brutalement des objectifs de prix et d’emploi qu’ils s’étaient fixés et sans modifier les taux de change.

Une analyse des essais de coordination internationale des politiques des divers pays aboutit à la conclusion qu’une véritable action internationale—distincte des échanges de vues internationaux variés ayant un caractère d’information—a de fortes chances de réussir en ce qui concerne des mesures spécifiques telles que les modification du taux de change, les tarifs douaniers, voire (ultérieurement) les taux d’escompte. En revanche, il n’y a guère lieu de supposer que la réalisation du plein emploi, des prix stables et de l’expansion que tous les pays désirent pourrait être nettement facilitée par l’acceptation des obligations internationales.

La mesure dans laquelle des objectifs nationaux divergents peuvent être absorbés par la balance des paiements est fonction des réserves internationales que les pays ont à leur disposition et des moyens supplémentaires qu’ils peuvent acquérir.

L’extension prise au cours de ces dernières années par les possibilités de tirage au Fonds Monétaire International —celles-ci représentent maintenant un quart de la liquidité internationale totale— a donné au Fonds un rôle central coordinateur des situations économiques dans différents pays. Dans le système monétaire international actuel le Fonds représente un successeur “dirigé” à l’étalon or “automatique.”


Este estudio que fue preparado para la reunión de la Sociedad Económica de Holanda celebrada el 9 de Diciembre de 1961, se refiere a ciertas cuestiones que aparecen en la página 149, en las que se establecía una marcada distinción entre algunos objetivos específicos de política económica y los medios con que se cuenta para lograrlos. Si bien dicha distinción resulta conveniente para la solución de algunos problemas, adolece de notables desventajas en el presente contexto. La necesidad de una acción internacional coordinada surge no tanto de los diferentes objetivos nacionales, como del deseo de los países de limitar el uso de los varios instrumentos de política. Al respecto se concentra particularmente la atención en el tipo de cambio y en el desequilibrio de la balanza de pagos: se admite generalmente que la estabilidad del tipo de cambio constituye una meta intermedia importante, pero que en un mundo sujeto a una evolución dinámica, la posibilidad de un déficit o superávit temporal en la balanza de pagos representa un medio valioso para llevar a cabo los objetivos nacionales relativos a precios y ocupación. En los diez últimos años, los países industrializados han podido generalmente invertir los desequilibrios de su balanza de pagos sin apartarse desmesuradamente de los objetivos de precios y ocupación y sin modificar los tipos de cambio.

Al analizar los esfuerzos hechos para lograr la coordinación internacional de las políticas nacionales, se llega a la conclusión de que una verdadera acción internacional—a diferencia de las discusiones internacionales sobre aspectos múltiples y de carácter meramente informativo—tiene grandes posibilidades de lograr buenos resultados en lo que toca a medidas específicas tales como modificaciones de los tipos de cambio, de las tarifas aduaneras y quizá (más tarde) de las tasas de descuento. Por otra parte, hay muy poca razón para suponer que el anhelo de todos los países de lograr la ocupación plena, la estabilidad de los precios y el progreso, pudiera encontrar un apoyo importante en la aceptación de obligaciones internacionales.

El grado en que la balanza de pagos pudiera absorber los múltiples objetivos nacionales depende de las reservas internacionales que se encuentran a la disposición de los países y de los recursos adicionales que éstos pudieran adquirir. El incremento registrado en los últimos años en la capacidad de girar contra el Fondo Monetario Internacional—que en la actualidad representa cerca de la cuarta parte de la liquidez internacional total—ha convertido al Fondo en una de las figuras centrales en la coordinación de la situación económica de los distintos países. En el sistema monetario internacional que rige hoy día el Fondo constituye el sucesor “dirigido” del patrón oro “automático.”


Mr. Polak, Director of the Department of Research and Statistics, is a graduate of the University of Amsterdam. He was formerly a member of the League of Nations Secretariat, Economist at the Netherlands Embassy in Washington, and Economic Adviser at UNRRA. He is the author of An International Economic System and of several other books and numerous articles in economic journals.


This paper is intentionally limited to the problems arising in and among the industrial countries.


J. Tinbergen, Economic Policy: Principles and Design (Amsterdam, 1956).


De Nederlandsche Bank N.V., Report for the Year 1960 (Amsterdam, 1961), p. 15.


Committee on the Working of the Monetary System, Report (Cmnd. 827, London, 1959), pp. 22-23. Specifically, the Committee listed its objectives as

“(1) A high and stable level of employment.

(2) Reasonable stability of the internal purchasing power of money.

(3) Steady economic growth and improvement of the standard of living.

(4) Some contribution, implying a margin in the balance of payments, to the economic development of the outside world.

(5) A strengthening of London’s international reserves, implying a further margin in the balance of payments.”


For a somewhat formal treatment, see Appendix (p. 178).


See the striking chart on the negative correlation between expenditure on producers’ durable equipment and on residential construction, 1947-59, in U.S. Congress, Joint Economic Committee, Staff Report on Employment, Growth, and Price Levels (Washington, December 24, 1959), p. 77.


De Nederlandsche Bank N.V., Report for the Year 1960 (Amsterdam, 1961), p. 16.


See his Centralization and Decentralization in Economic Policy (Amsterdam, 1954).


Ibid., p. 75.


“Beyond the traditional interest rate and open market policies and public finance, the following should also be considered as important not only for internal, but also for external balance: the size and the nature of government expenditures and taxes, subsidy policies, social policies, and, last but not least, wage and price policies.

“The acceptance of the coordination of internal policies by the most important countries in international trade presents itself therefore as a necessity, if one puts international exchange rate stability as a primary goal.” (See page 7 of “Welt-wirtschaft und Waehrungsstabilitaet,” a paper (mimeographed) presented to the General Association of Netherlands Chambers of Commerce in Zürich, Switzerland, April 27, 1961.)


This statement is limited to the industrial countries. The primary producing countries have no means of defending themselves in the short run against declines in their terms of trade that are due to deflationary developments abroad.


General Agreement on Tariffs and Trade, Trends in International Trade: A Report by a Panel of Experts (Geneva, October 1958), p. 107.


The other two are “higher standards of living” and “conditions of economic and social progress and development.”


“The co-ordination of national employment policies has not become a feature of international life, although full employment and the elimination of unemployment continue to be almost universal objectives of national policy, as they would have been had there been no United Nations.” See Robert E. Asher, Walter M. Kotschnig, William Adams Brown, Jr., James Frederick Green, Emil J. Sady, and associates, The United Nations and Promotion of the General Welfare (Brookings Institution, Washington, 1957), p. 1053.


As to what a national wage policy is, and especially what it is not, see The Problem of Rising Prices, Report by a Group of Independent Experts to the Organization for European Economic Cooperation (Paris, 1961), p. 58.


League of Nations, World Economic Survey, 1931-32 (Geneva, 1932) pp. 233-35.


Canada is an exception to the rule in regard to the discount rate, as it is in regard to the exchange rate. In recent years, the Canadian discount rate has been set weekly at ¼ per cent above the prevailing Treasury bill rate.


See the discussion in the International Monetary Fund’s Annual Report, 1961 (Washington, 1961), pp. 8-9. Quite apart from official action to peg the forward rate, the forward exchange mechanism can in certain circumstances be relied upon to minimize the international impact of national interest rate differentials. This mechanism assures the insulation of national money markets only insofar as forward rates are primarily determined by the market for funds seeking covered arbitrage. If, however, as is often the case, the forward rate is strongly influenced by expectations about the spot rate, the mechanism ceases to act as an automatic dampener of interest rate differentials, and may indeed increase interest differentials in some directions.


U.S. Congress, Joint Economic Committee, International Payments Imbalances and Need jor Strengthening International Financial Arrangements, Hearings Before the Subcommittee on International Exchange and Payments, May 16, June 19, 20, and 21, 1961 (Washington, 1961), p. 113.


Board of Governors of the Federal Reserve System, The Federal Reserve System: Purposes and Functions (Washington, 4th ed., 1961), pp. 47-48.


Ibid., p. 76.


Per Jacobsson, Towards a Modern Monetary Standard, The Stamp Memorial Lecture, November 19, 1959 (London, 1959), p. 19.


“When a broader view is taken of the Fund’s role in supporting international liquidity, it would seem reasonable for each country to regard the unused portion of its drawing rights as part of the foreign exchange resources which it may utilize. Under the Fund’s Articles of Agreement, countries are entitled, when certain conditions are fulfilled, to purchase foreign exchange equivalent to their gold subscriptions plus 100 per cent of their quotas in the Fund. On the assumption that all members were eligible to purchase the full amounts, drawing rights in the Fund amounted, at year-ends, to the equivalent of $10.7 billion in 1957, $11.0 billion in 1958, $17.0 billion in 1959, and $18.1 billion in 1960.” See International Monetary Fund, Annual Report, 1961, p. 114.


On the question of how automatic this standard was, see Arthur I. Bloomfield, “La Politique Monétaire dans le Régime de l’Etalon-or International: 1880-1914,” Banque Nationale de Belgique, Bulletin d’Information et de Documentation, January 1959, pp. 1-20.


See International Monetary Fund, Articles of Agreement: “Article I. Purposes “The purposes of the International Monetary Fund are:

(i) To promote international monetary cooperation through a permanent institution which provides the machinery for consultation and collaboration on international monetary problems.

(ii) To facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy.

(iii) To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation.

(iv) To assist in the establishment of a multilateral system of payments in respect of current transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of world trade.

(v) To give confidence to members by making the Fund’s resources available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.

(vi) In accordance with the above, to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members.”


For example, the exchange rates on the dollar of all currencies except that of the United States. Under convertibility, these (N-1) rates of exchange determine all other rates through the arbitrage mechanism of the exchange market.


For greater precision one could make an allowance here for net gold production.


It has been dealt with by J.J. Polak and Ta-Chung Liu in “Stability of the Exchange Rate Mechanism in a Multi-Country System,” Econometrica, Vol. 22 (1954), pp. 360-89, and by Robert A. Mundell in “The Monetary Dynamics of International Adjustment Under Fixed and Flexible Exchange Rates,” Quarterly Journal of Economics, Vol. LXXIV (1960), pp. 249-50.