The common policy goals of industrial countries are a high level of employment and satisfactory growth of output, avoidance of price inflation, and a balance of payments position that is at least tenable or that actually permits the accumulation of reserves. These objectives are not necessarily mutually consistent. Each country is in practice bound to strike a balance giving greater or lesser emphasis to particular goals. Moreover, the objectives of one industrial country and the policy measures that it employs to achieve them may be incompatible with the realization of another country’s targets. Countries have shown themselves unwilling to operate an automatic mechanism for the adjustment of payments disequilibria, rightly judging that, in these circumstances, conscious efforts at compromise are needed to promote the forms of adjustment most conducive to the fullest possible realization of the common policy goals by the industrial countries as a group.


The common policy goals of industrial countries are a high level of employment and satisfactory growth of output, avoidance of price inflation, and a balance of payments position that is at least tenable or that actually permits the accumulation of reserves. These objectives are not necessarily mutually consistent. Each country is in practice bound to strike a balance giving greater or lesser emphasis to particular goals. Moreover, the objectives of one industrial country and the policy measures that it employs to achieve them may be incompatible with the realization of another country’s targets. Countries have shown themselves unwilling to operate an automatic mechanism for the adjustment of payments disequilibria, rightly judging that, in these circumstances, conscious efforts at compromise are needed to promote the forms of adjustment most conducive to the fullest possible realization of the common policy goals by the industrial countries as a group.

The common policy goals of industrial countries are a high level of employment and satisfactory growth of output, avoidance of price inflation, and a balance of payments position that is at least tenable or that actually permits the accumulation of reserves. These objectives are not necessarily mutually consistent. Each country is in practice bound to strike a balance giving greater or lesser emphasis to particular goals. Moreover, the objectives of one industrial country and the policy measures that it employs to achieve them may be incompatible with the realization of another country’s targets. Countries have shown themselves unwilling to operate an automatic mechanism for the adjustment of payments disequilibria, rightly judging that, in these circumstances, conscious efforts at compromise are needed to promote the forms of adjustment most conducive to the fullest possible realization of the common policy goals by the industrial countries as a group.

Disequilibria in international payments may be corrected either by changing internal policies, or by changes in exchange rates, or by altering the conditions for foreign transactions (for instance, by changes in trade restrictions and tariffs, or measures to encourage or discourage capital flows) or by changing foreign aid policy. If restrictions on trade and payments are to be minimized, equilibrating changes in prices or exchange rates will be needed unless adjustment is to be achieved mainly by variations in relative rates of growth. Even if relative prices, at fixed exchange rates, were originally such that all countries were in payments equilibrium, such a system would tend to run into increasing difficulty as time went on if complete price stability prevailed in all countries. Payments imbalances would develop as a result of such factors as the exhaustion of natural resources; technical development leading to the replacement of certain industries by others; changes in the size of populations, or in standards of consumption, affecting the self-sufficiency of particular countries; the faster growth of trade unions or cartels in one economy than in another; or political events, such as unions between existing countries or the achievement of independence by others.

The automatic adjustment of payments disequilibria is conceivable either through a system of flexible exchange rates or through an “ideal” gold standard. Under the former, the external payments situation is permitted to determine the exchange rate and therefore the relation between domestic and foreign prices. Under an “ideal” gold standard, in a world of flexible prices, gold flows would automatically bring about the changes in domestic credit conditions needed to restore equilibrium by changing the relative levels of prices (in terms of gold) in various countries.

If the adjustment mechanism were completely automatic, the actual level of international liquidity would be immaterial. If exchange rates were perfectly flexible, there would be no deficits or surpluses requiring to be financed. If changes in gold holdings had automatic consequences on the money supply and prices were flexible, changes in gold holdings (whatever their initial scale and distribution) would always suffice to bring about the changes in relative prices needed to restore payments equilibrium.

The question of the level of reserves that is required becomes important if countries are not prepared to operate a fully automatic adjustment system. It arises, for instance, under a system of managed flexible exchange rates, where fluctuations in rates are smoothed by official intervention. It is liable to arise in practice under any gold standard system because the gold-receiving country is under no equal compulsion to expand credit and allow its prices to rise, when the gold-losing country has to contract credit to maintain its reserves. Furthermore, in the real world of price inflexibility and structural rigidities, countries have a strong incentive to build up “excess” reserves of gold when in surplus, since the process of adjustment imposed on deficit countries is a more painful one if external balance has to be restored principally by reducing activity and incomes rather than through changes in relative price levels in different countries.

When changes in reserves are allowed to take place without causing changes in internal credit conditions, they become the means of financing a deficit or surplus position, while adjustment takes place more slowly than would otherwise be possible or is postponed for the time being. Countries’ demands for reserves and international credit facilities will be greater, the less willing they are to adjust their domestic policies or to introduce restrictions upon external transactions1 or to change their exchange rates in order to correct payments disequilibria. Actual world reserves and international borrowing facilities may be scanty or ample in relation to total demands. The more marked is the degree of stringency (ease) in the supply of international liquidity, the sooner the deficit (surplus) countries will be obliged by shortage of reserves (by inflationary pressures) to forego certain of their domestic policy goals or to alter either their exchange rates or the existing level of trade and payment restrictions.2

Postwar Development of the International Payments System

One of the basic aims of postwar reconstruction policies was to create an international system in which national authorities would be free to direct their monetary and fiscal policies to the attainment of full employment goals, provided that they abstained from measures calculated to promote the fulfillment of their own objectives at the expense of other countries, such as competitive exchange depreciation or restrictive trade policies. Under the Articles of Agreement of the Fund and the General Agreement on Tariffs and Trade (GATT), temporary imbalances were to be met by the use of gold and foreign exchange reserves and other forms of compensatory financing, that is to say, by the use of “international liquidity.” The maintenance of a tenable payments position was to be ensured by three main instruments of adjustment, namely, by (1) changes in exchange rates in accordance with Article IV, Sec. 5, of the Fund Agreement, (2) restrictions of capital outflow, and, if need be, (3) restrictions on imports, to the extent that this was permissible under the rules of the GATT.3 The general aim of the system was to permit payments disequilibria to be overcome with the least possible hindrance to the achievement of full employment and freedom of international trade, and with the least sacrifice of the advantages of a system of fixed exchange rates. But the accent was on full employment: to avoid deflationary internal policies, countries were to be permitted to adjust the balance of payments directly, both by the unconditional right to control capital movements and by the conditional right to impose import restrictions without much risk of retaliation if reserves were low or falling; and a need for fairly numerous alterations in exchange rates was foreseen, at least initially.4

In the immediate postwar period, the failure of the attempt in 1947 to re-establish the convertibility of sterling was followed by the Marshall Plan (which enabled European countries to finance imports which they otherwise could not have purchased) and by a major realignment of industrial countries’ exchange rates in 1949. As payments positions eased in subsequent years, the cumbersome system of currency and import controls and the whole machinery of bureaucratic restraint became increasingly unpopular. A strong movement for import liberalization, and later for the easing of restrictions on capital movements, resulted in the establishment of nonresident convertibility in 1958, and culminated, after further easing of restrictions on international payments, in the assumption by most of the industrial countries of the obligations of Article VIII of the Fund Agreement.

During the first decade or so after 1949, the principal stimulus to expansion in a number of countries came from rapid export growth, favored by advantageous exchange rates, limited purchasing power in the domestic market, and official recognition of the need to encourage exports in order to pay for essential imports. In several of these countries it had been necessary to re-establish exchange rates de novo during the period of reconstruction, when there was almost no way of deciding what rate would be appropriate at more normal levels of employment, output, and productivity in the economy.5 This was the case in Germany, Japan, and Italy; the position was rather similar in the Netherlands, where the guilder had been devalued during the war. It was still not clear by 1949 what exchange rates would be appropriate for these countries under less abnormal conditions.

In these and several other developed countries, the possibility of expanding output rapidly without incurring severe pressure on prices from wage costs (as distinct from demand) was facilitated by ample opportunities for shifting manpower away from low-productivity, low-income sectors (such as agriculture and other small-scale self-employment sectors), by rapid growth in the total labor force, or by the existence of widespread unemployment and underemployment. Employers were consequently able to expand employment in the industrial sector rapidly from year to year without encountering the same increase in the strength of trade union bargaining power, or the same tendencies for competitive bidding up of wages by employers themselves, as were experienced in other economies where there was more stringency in the labor market.6 Consequently, these countries were able to maintain or improve their favorable competitive position with respect to prices in export markets. At the same time, the rapid growth of the industrial sectors of these economies enabled them to offer an increasingly wide range of manufactures and to catch up with the technical leadership which the United States possessed at the end of the war. France (which experienced strong demand inflation and a deterioration in its competitive position during the earlier 1950’s) was in the favorable situation described here following its substantial devaluation in 1958.

For a considerable period of time, the effects of favorable exchange rates and the competitive strengthening of these countries’ positions was obscured by their gradual liberalization of external transactions and the consequent rise in their imports of goods and services. This in turn reduced the pressure on the payments positions of other industrial countries. As long as there was still scope for expansion without undue pressure in the labor market or on the level of wages and prices in the economy, the countries in a favorable competitive position were content to remain in surplus, allowing increasing surpluses, and the monetary consequences of their growing reserves, to stimulate further increases in industrial employment.

At this stage, moreover, a considerable degree of elasticity was imparted to the international monetary system by the disproportionate concentration of world gold holdings in the United States at the end of the war, by the respect in which the U.S. dollar was held because of its unique position as the only major convertible currency, and possibly because holdings were felt to be physically safer in the United States than in other countries. These circumstances permitted an expansion of effective liquidity as the need for it increased with continuing surpluses, by (1) a better distribution of available gold stocks and (2) increased holdings of U.S. dollars as official reserves. (In fact, the surplus countries increased their holdings of gold and dollars roughly pari passu.) Consequently, large and persistent surpluses did not involve serious pressures on the deficit countries, particularly the United States, through reserve losses. Clearly, however, the decline in U.S. gold stocks could not continue indefinitely.

The re-establishment of external convertibility in 1958 greatly increased the scope for movements of private capital to take advantage of interest rate differentials, or, through direct investment, of more favorable profit possibilities or lower rates of taxation abroad. It also incidentally increased the scope for speculative capital movements in anticipation of exchange rate changes and for capital transfers as a means of tax evasion. While it was outside the United States that restrictions eased, the most important consequence over the next few years was the greatly increased outflow of private capital from that country to Western Europe and Japan. This large outflow was a major influence in transforming the U.S. deficit from a welcome means of improving world liquidity to a problem tending to impose a constraint on U.S. economic policy and upon the operation of the gold exchange standard. Large deficits of the United States after 1958 both reduced its gross reserves and increased its liabilities. As a result, U.S. gold reserves came to appear less clearly adequate and some resistance developed abroad to a further accumulation of dollar holdings and thus to an extension of the reserve currency system. The greater mobility of capital also weakened the effectiveness of credit policy as an instrument for curtailing domestic demand and created an incentive for countries to adopt contractionary monetary and budgetary policies when these were not called for by domestic conditions, in the hope of restoring “confidence” and so forestalling or reversing speculative outflows of capital. Moreover, the risk of such speculative movements led to increased emphasis on the need to avoid changes in exchange rates.

To sum up, for the industrial countries of Western Europe and Japan the period of somewhat more than a decade after the war was one of transition from a situation of substantially less than complete utilization of labor resources and widespread and severe restrictions on international transactions to one of almost full employment and substantial freedom of international trade and payments. Adjustment of surplus positions did not pose intractable problems as long as there was considerable scope for expansion in the surplus countries, and these economies had the possibility of reducing their surpluses by lowering restrictions and tariff barriers. Benefiting from the expansionary forces of increasing employment and trade liberalization in the surplus countries, deficit countries could adjust their positions by a comparatively slight check to aggregate demand and investment, or by delays in liberalization, thus slowing the growth of imports and securing a faster growth of exports.7 Furthermore, there was in general no great pressure for speedy adjustment of surplus and deficit positions as long as major surplus countries were seeking to build up their depleted reserves and the major deficit country, the United States, was in a position to welcome a reduction of its ample reserves, whether by gold sales or by increasing its liabilities to foreign monetary authorities.

This perhaps exceptionally favorable environment, and the greater leeway provided for many countries by increased reserves, led to growing confidence that adjustment of surplus and deficit positions could be secured by monetary and fiscal measures without undue repercussions on the domestic policy goals of full employment, adequate growth, and price stability. This belief, and the wish to avoid the risk of speculative capital movements, encouraged a tendency among the major industrial countries to interpret the Bretton Woods agreement as providing for virtual fixity of exchange rates in all but the most exceptional circumstances.

Shortcomings of Existing System

If surplus and deficit positions were always to be speedily corrected by changes in internal financial policy, the present system would be essentially similar to the classical gold standard, under which changes in reserves brought about changes in the level of economic activity and prices. Clearly, however, such an adjustment process must involve some conflict with the achievement of the domestic policy objectives unless there is scope for expanding output and employment in the surplus countries without the risk of immoderate price inflation, or unless the level of aggregate demand in the deficit countries is more than would be sufficient to ensure high employment at reasonably stable prices.

If prices are highly responsive to increases in demand in the surplus countries (which may be the case at full employment), the adjustment of payments imbalances will be facilitated, even if prices in the deficit countries are sticky in a downward direction. However, if the surplus countries maintain price stability by restricting domestic demand, adjustment by the deficit countries will tend to conflict with their employment objectives unless wages and prices are flexible in a downward direction, facilitating a rapid switch of resources into exports and substitutes for imports.8 (If prices remain unchanged, however, or if resources are not perfectly mobile, resources released from industries producing for domestic use may not find an export market; imports will then be reduced only as they tend to fall with declining income, and not by the substitution of domestic goods for foreign goods.)

Commentators frequently seem to imply that changes in relative prices can be achieved comparatively quickly by a little more expansion here or restriction there.9 Starting from existing price levels, surplus countries are to expand and prices will rise, deficit countries are to contract and prices will fall, resulting in the necessary adjustment of competitive positions.10 The underlying assumption seems to be that it is equally feasible for all countries to achieve reasonable employment goals without incurring price inflation or deficits on the balance of payments. However, some countries may be in deficit precisely because wages and prices tend to rise appreciably when (reasonable) targets for employment and growth are met, while surplus countries may be those which are most successful in achieving their employment and growth goals without price inflation. Restrictive measures in the deficit countries may then merely slow down but not prevent an upward trend of prices; and even if surplus countries were to allow an accelerated rate of growth to bring about an upward trend in their prices, it does not follow that the competitive position of the deficit countries would be improved or even maintained.

While the pursuit of full employment targets tends to create upward pressures on prices, these pressures vary considerably from country to country. Their strength depends not only on the flexibility of the supply of labor and differences in the power of trade unions, industrialists, and other social groups to secure increases in their money incomes; it is liable to be affected by the rate of growth of productivity, which makes it more or less feasible to satisfy aspirations for rising incomes without incurring increased money costs. It is also likely to be strongly influenced by past experience of unemployment or shortages of labor, and by the degree of priority accorded to price stability as a goal of national policy. In the Federal Republic of Germany, for example, far greater importance is naturally attached to price stability by all sectors of the population that have experienced the breakdown of the monetary system twice in a lifetime, than in some nearby countries where years of increasing prices have not given rise to disaster, but are, on the contrary, associated in the public mind with high levels of employment and prosperity. The importance of such historical factors may tend to decline over a period of years—for example, as the growth of output leads to a fuller utilization of labor resources or as the continued maintenance of high levels of employment gradually strengthens the organization and aggressiveness of trade unions. But as long as the surplus countries attach a higher priority to price stability than do other countries, they will tend to encounter increasing pressures of demand from the export sector and will be inclined to offset such pressures by measures to restrain internal demand. “Adjustment” by the surplus countries may therefore be delayed until their competitive cost advantage becomes excessively strong. At this point the economy may be faced with an explosive expansion in the export sector and the risk that efforts to maintain price stability may be self-defeating, such as influenced the policy of the German Federal authorities at the time of the revaluation of the deutsche mark in 1961, or with large-scale movements of labor to neighboring countries where wages have become relatively more favorable, such as occurred in the Netherlands during 1963. Alternatively, the continuation of the offsetting policies may impinge increasingly upon such goals as the maintenance of an adequate rate of private investment in the economy, or of an adequate level of public expenditure on the social infrastructure, housing, education, defense, or foreign aid.

On the other hand, it is unlikely that wages and prices in the deficit countries will respond quickly to measures restricting demand, if these are regarded as a merely temporary abandonment of policy goals which no government can for long neglect if it is to stay in power. Even if the upward tendency of wages and prices tends to abate after several years of restraint, the process of cost inflation may tend to begin anew, with accumulated vigor, when the balance of payments position eases and expansion is resumed.

In brief, equilibrating changes in relative price levels are fraught with difficulty, because those countries which are free to let prices adjust naturally by permitting them to rise, may not be prepared to do so, and those countries which are forced to adjust cannot improve their competitive position greatly because it is much more difficult to force prices and wages down than to let them rise. To the extent that surpluses and deficits arise from incompatible policy targets between countries, the adjustment process would require countries which attach a high priority to price stability to inflate, and countries which have proved incapable of reconciling their employment targets with price stability to concentrate on improving their relative prices at the sacrifice of employment targets that they consider even more important than price stability.

Furthermore, it is questionable whether deficit countries can count on securing a lasting improvement in their payments position by the application of more restrictive financial policies than are called for by internal conditions, or whether the adverse effects of such disinflationary measures in terms of unemployment or output foregone over a period of years can be disregarded. Even in the short run, the improvement on current account derived from such restrictive monetary and fiscal policies may be partially, or even more than completely, offset by a worsening on capital account, if the now relatively more favorable prospects of economic growth in surplus than in deficit countries encourage increased capital flows from the latter to the former. In their attempt to avoid this consequence, deficit countries have a strong incentive to raise interest rates in relation to those in surplus countries, thereby promoting an immediate but essentially temporary improvement in their payments position by attracting a larger proportion of (limited) mobile short-term funds. In the longer run, there seems little reason to believe that lowering the present rate of growth in deficit countries will serve to overcome the underlying disequilibrium by strengthening their position vis-à-vis surplus countries. The improvement in their present payments position may be achieved at the expense of the future growth of productivity since the level of business investment is affected both by the scope for “self-financing” by enterprises and by the cost of borrowing. A lower rate of productivity investment is liable to be reflected in declining “technical competitiveness” of the country as an exporting nation a few years hence.

Possible Changes in the Existing System

Observers who have studied these difficulties are sharply divided between those who believe that the existing system should be drastically altered, so as to provide a swifter and more automatic mechanism of adjustment, and those who believe that, on the contrary, “the main disadvantage of the present system is that it requires countries to restore balance in their payments more rapidly than may be consistent with important objectives of policy,” 11 and that there is a pressing case for accepting the comparatively slow correction of payments imbalances and providing adequate means of financing prolonged surpluses and deficits of major industrial countries.

The first group includes both the advocates of an automatic gold standard system and the protagonists of freely fluctuating exchange rates. As explained earlier, it is difficult to see how the proposal that the internal level of activity should be automatically determined by the balance of payments situation is to be reconciled, in a world of price rigidities and freedom from restrictions on international transactions, with political mandates to pursue full-employment policies. Academic economists are, therefore, increasingly attracted to the idea of flexible exchange rates under which balance of payments adjustment would be brought about automatically on the foreign exchange market, leaving monetary and fiscal policy free, at least in principle, to be determined in accordance with the requirements of internal developments. However, it appears unlikely that governments could be persuaded to adopt this solution in the immediate future. Nor is it certain that a system of flexible exchange rates would in practice be operated so as to permit countries greater freedom in determining their domestic policies 12 and at the same time avoid an increase in the risks of foreign trade and long-term private investment.

Those who press for less radical changes in the system base their case on the view that there may be no compelling reason to press for speedy adjustments if the continuation of deficit or surplus positions for a number of years permits countries in general to achieve their internal policy targets of high employment, growth, and price stability to a fuller degree. They emphasize (1) that although surpluses and deficits may persist for long periods, the causes of such imbalances frequently tend to abate in time, (2) that tendencies to adjustment can be strengthened by discretionary policies rather than by instituting automatic adjustment mechanisms, (3) that to the extent that imbalances impose intolerable pressures on particular countries or lead to unwarranted transfers of resources between countries, recourse can be had to the weapon of infrequent exchange rate adjustments. They note also that the provision of adequate international liquidity to permit the gradual correction of payments imbalances can be met within the existing monetary system although annual additions to monetary gold are small in relation to growing demands for reserves; increased liquidity may be provided either through net lending by international organizations, or through the deficits, financed by increased foreign holdings of the currencies, of countries with a good record of internal financial stability.

The three points stated above merit brief discussion.

1. Tendencies for shifts in surplus and deficit positions

Protracted balance of payments disequilibria of major industrial countries are often associated with once-and-for-all changes in the world economic situation. In such a context there is frequently a tendency for transactions stimulated by the change (which are reflected in deficit and surplus positions) to reduce progressively the force of the original stimulus so that the deficit (or surplus) may decline or even reverse in time. For example, the “dollar problem” reflected the abnormal situation which prevailed at the end of the war, when the wartime disruption of economic activity in most of Europe and Japan rendered these countries, and most of the world, abnormally dependent on imports from North America. The rebuilding of European and Japanese industrial potential, with the help of heavy imports of capital goods and raw materials, gradually reduced this abnormal dependence, and the consequent rapid growth in productivity in these countries was a major factor underlying the strengthening of their competitive position vis-à-vis the United States. The subsequent easing of restrictions on capital movements, made possible by the stronger payments positions of Western Europe and Japan, constituted another once-and-for-all change. The fact that heavy U.S. private investment in Europe and Japan now became feasible for the first time in decades meant that an accumulation of profitable openings became apparent all at once; furthermore, the establishment of the European Economic Community provided an exceptional stimulus to direct investment behind the coming tariff barrier. As a result of these forces, concern over the “dollar shortage” was replaced, within a decade, by concern over the U.S. external deficit.

The attainment of full employment and absorption of manpower reserves in Western Europe, while there is still less than full employment in North America, represents yet another major change in the world economic situation which could profoundly alter the balance between the two areas. In Western Europe and Japan it may become more difficult than in the recent past for industry to lower or even to maintain manufacturing costs and prices or to expand export production. In these circumstances, a high rate of business investment in the United States (leading to replacement of obsolescent plant and equipment), accompanied by smaller increases in wages than those occurring in Europe, could result in a marked strengthening of the U.S. competitive position and an improvement in its current account. More significantly—since the recent pressure on U.S. reserves has arisen mainly on capital account—the forces making for a rise in the U.S. rate of growth relative to that of Western Europe may serve to reduce the net flow of private capital from the United States to Western Europe. Over the longer term, rising per capita incomes and savings in Europe and Japan, the inflow of U.S. capital itself, the influence of U.S. investors, and measures taken by foreign governments to restrain the inflow of U.S. capital are all factors favoring the development of local capital markets or the lowering of interest rates.

In present circumstances, with the ruling emphasis on the achievement of full employment and a satisfactory growth rate, automatic or semiautomatic adjustment tendencies are neither as strong nor as rapid as under the gold standard, but they are by no means absent. Increasing disequilibria owing to a secular change in the competitive situation or to a persistently faster rise in the price level in some countries than in others will tend to generate increasingly powerful pressures toward adjustment. The continuous worsening of a country’s competitive position in third markets, and the penetration of its domestic market by foreign producers, may tend to bring forth a growing response on the part of the business community. On the positive side, this may result in increased efforts to raise productivity and labor efficiency and in more active export promotion. It is also likely to strengthen entrepreneurs’ resistance to wage increases. More negatively, it will strengthen demands for “adjustment” through measures such as tariff increases, administrative restriction of imports, tying of aid, increased export credit facilities, and changes in the tax system designed to strengthen the position of export or import-competing sectors vis-à-vis their foreign competitors, to raise the cost of borrowing to foreigners, or to reduce the tax incentives to investment (and the reinvestment of foreign-earned profits) abroad. Such responses influence not only the current but also the capital account.

Surplus countries, too, are subject to forces making for balance of payments adjustment. Efforts to offset inflationary pressures emanating from the external sector by monetary measures of restraint, directly or indirectly tending to raise interest rates, are liable to be frustrated by an increased inflow of funds from abroad. The government may restrain the degree of inflationary pressure for a year or two by cutting back public expenditure, or by restraining private investment through changes in depreciation allowances, or by limiting private consumption (for example, by changes in indirect taxation and hire-purchase regulations). But such policies become progressively more difficult to apply; indeed, as time goes on it becomes increasingly difficult to maintain even the same reduced level of public expenditures or the same limitation of private investment and consumption. In this situation there will be a growing tendency to seek adjustment by changing the conditions for current and capital transactions by measures like those mentioned in the preceding paragraph (but in reverse).

Such forces toward the adjustment of the payments position work comparatively slowly. Payments disequilibria must, therefore, be expected to persist for longer periods, and to require larger means of financing, than would be the case if gold standard “rules of the game” were being applied.

2. Long-term policies to strengthen the adjustment mechanism

It is not possible here to do more than offer a few observations on some of the many ways in which tendencies to adjustment within the existing system may be strengthened by deliberate action of national authorities.

Payments imbalances are frequently compounded by the use, to secure internal policy objectives, of measures which are likely to have undesired consequences on the balance of payments. Considerable attention has recently focused on the appropriate combination of monetary and budgetary policies.13 This has tended to point up the extent to which payments disequilibria are made more intractable by institutional weaknesses in the budgetary and monetary systems of particular countries, and the considerable scope for improving the adjustment mechanism by strengthening the range and flexibility of monetary and fiscal weapons at the disposal of the national authorities.

It has been argued, for example, that monetary policy is to be preferred as a weapon of external adjustment and expansionary or restrictive fiscal policy as an instrument for securing internal stability because interest rate policy is more effective, by comparison with fiscal policy, in influencing the balance of payments than in influencing the level of internal activity.14 This analysis suggests that greater budgetary flexibility could have been helpful in reducing the scale of recent German surpluses and U.S. deficits by allowing fiscal and monetary measures to complement one another more fully. In the United States, the difficulty of securing changes in the tax structure and the fact that a progressive tax system is liable to absorb an increasing proportion of total income as prices and money incomes rise have tended to restrain private demand and, by causing greater reliance on monetary policies for expansion than might otherwise have been needed, have made it more difficult to improve the payments position. The maintenance of a high level of long-term interest rates in the Federal Republic has been a factor tending to increase the magnitude of its payments surplus in recent years. Renewed large-scale borrowing by the Government and other public bodies gave considerable support to long-term rates in 1963.

Considerable interest has recently focused on “incomes policy” measures. While such measures are likely to become of growing importance as a possible means of mitigating tendencies to cost inflation under full-employment conditions, there has probably been undue optimism concerning their use as a flexible tool to influence the rate of increase in average wage costs in accordance with the balance of payments position. If incomes policies are generally adopted, there is no guarantee that they will be most effective in the countries most prone to cost pressures—in fact the reverse is likely to be the case. However, such policies could contribute to the adjustment process, if it should prove easier to secure their adoption and implementation in the context of persistent difficulties on the balance of payments, than in the context of fear of inflation without an immediate payments problem. Moreover, even if incomes policy measures were generally adopted, confidence in their effectiveness in limiting upward movements of wages and prices might encourage the authorities in surplus countries to allow the expansionary forces resulting from the payments position to have greater effect.

Given the great importance of government transactions in international payments balances, tendencies to adjustment could be strengthened by increased collaboration in international aid and defense arrangements, by administrative arrangements altering the timing of various countries’ participation in aid schemes, or by varying the proportion of tied and untied aid provided to the less developed countries by the major industrial countries in accordance with their balance of payments positions.

3. The case for adjustment of exchange rates

The Fund Articles of Agreement contemplated a system of so-called adjustable pegs, under which rates could be changed at rather infrequent intervals. But it envisaged a system of restrictions on speculative and other undesired capital movements which was never fully effective and which national authorities would probably be unwilling, and even unable, to reintroduce today. Professor Tobin has stressed that “if the pegs are never changed … we deny ourselves the use of an important instrument of adjustment, in many ways the simplest, most powerful, and least costly instrument. This means that the burden of correcting imbalances has to be assumed by more far-reaching and time-consuming processes of adjustment.” 15 But the possibility of changes in rates under the adjustable peg system, together with the increased freedom for the movement of capital, inevitably leads to speculation against countries in a weaker balance of payments position. The maintenance of the system requires that monetary authorities stand ready to cooperate in countering such speculative movements. In recent years there has been satisfactory progress toward such cooperation.16

If the objectives of full employment and growth are not to be renounced to some extent in some countries, relative price adjustments must eventually occur in one way or another. As was described in section 1 above, such price adjustments may be postponed by an increasing tendency for both deficit and surplus countries to resort to various forms of interference intended to curb pressures from the external sector. Resistance to price adjustment is, therefore, likely to produce a proliferation of such devices as ad hoc import restrictions or tariff increases, rules limiting official purchases of foreign goods and services, tax discrimination in favor of export or import-competing industries, interest equalization taxes, special reserve requirements on foreign liabilities of the banks, and direct limitation of foreign investment. Some of these measures produce the same effect as selective depreciation (or appreciation) of the currency under a system of multiple exchange rates. Others are mere substitutes for more direct trade and exchange restrictions which are barred under the provisions of the GATT and the Fund. In general, the devices adopted are hardly likely to be the most effective for the purpose, since they are chosen not for their relative efficiency but to take advantage of various, largely accidental, loopholes in the legal framework of international agreements. If, despite such measures, the attainment of the desired level of employment and rate of growth results in increased payments imbalances, the surplus countries are almost certain to face difficulty in containing inflationary pressures emanating from the external sector. Relative price adjustment may then be brought about automatically via inflationary pressures in the countries with undervalued currencies, or deliberately, by a decision to appreciate the exchange rate in order to avoid the disruptive effects of domestic price inflation. Alternatively, the surplus countries may endeavor to lessen the upward pressure on their prices by advocating that the deficit countries should adjust their positions and seek to enforce this view by limiting the expansion of international liquidity. If the deficit countries are determined to attain their policy objectives, their increasing difficulty of doing so under these conditions will greatly increase their incentive to bring about the relative price adjustment by devaluation.


In the course of the last decade the difficulty of securing rapid adjustment of major payments disequilibria among developed countries has become increasingly evident. Surplus countries, at practically full employment, are reluctant to alter their domestic policies in order to reduce their surpluses, because of conflict with the objective of internal price stability. Deficit countries find it difficult to attain a desired level of employment without running into upward pressure on prices.

There may be no particular virtue in speedy adjustment of payments disequilibria if a slower adjustment of deficit and surplus positions permits countries in general to achieve their internal policy objectives as regards employment, growth, and price stability to a fuller extent. It would seem desirable in many cases to permit countries to aim at correcting deficit or surplus positions comparatively slowly. But this requires the firm assurance that requisite financing, in one form or another, will be provided, in order that the international system should not be subject to periods of strain as appropriate corrective policies are evolved.

However, the achievement of internal policy objectives will grow harder if serious price disparities have gradually developed under a system of fixed exchange rates. An economy at full employment with prices that are becoming excessively favorable in terms of foreign currencies will find its internal price stability threatened by pressures from the external sector. At less than full employment, a highly unfavorable price situation would tend to impede the attainment of a higher rate of activity and employment, even if it were possible to finance almost unlimited deficits.

There are powerful forces of resistance to any change in exchange rates. Devaluation is regarded as a blow to the prestige of the currency and is not without its effect on attitudes to holding the currency in question. On the other hand, revaluation is naturally bitterly opposed by businessmen in the export and import-competing sectors, to whom it appears as an arbitrary act of government to reduce the proceeds of their successful competitive efforts. Nevertheless, recent history has seen two interesting instances in which appreciation was resorted to in order to enable a surplus country in a full-employment situation to reduce the pressures on internal stability arising from a strongly favorable competitive position. It may be that the postwar reaction to the frequent changes in rates in the 1930’s will be found to have been carried too far.

Ajustement de la balance des paiements entre pays développés


Si l’on veut réduire au minimum les restrictions auxquelles sont soumis le commerce et les paiements, des changements tendant à équilibrer le rapport des prix dans divers pays s’imposent à moins que l’ajustement ne s’effectue principalement par des variations de taux de croissance. Théoriquement, de tels changements de prix peuvent être engendrés automatiquement par des taux de change flexibles ou par un “idéal gold standard” dans un monde de prix flexibles. Il devient alors important de déterminer le niveau des réserves nécessaires si les pays ne sont pas en mesure de laisser jouer un système d’ajustement entièrement automatique.

D’une façon générale, l’ajustement des déséquilibres n’a posé aucun problème grave au cours de la période d’après-guerre tant qu’il a été possible de réduire les restrictions et les tarifs douaniers et d’envisager une expansion dans les pays excédentaires, et tant que les pressions s’exerçant en faveur d’une correction rapide des déséquilibres se trou-vèrent mitigées par le fait que les pays excédentaires cherchaient à accumuler des réserves et que les Etats-Unis se préoccupaient peu des réductions de leurs propres réserves. Ceci porta à croire que l’ajustement recherché pouvait être réalisé par des mesures financières intérieures n’entraînant pas de conflit sérieux avec les objectifs visés en matière d’emploi, d’expansion et de prix; ceci encouragea aussi à interpréter les Statuts du Fonds comme prévoyant des taux de change pratiquement fixes. Avec le système actuel, toutefois, il est difficile d’amener des changements tendant à équilibrer les niveaux des prix.

On a soutenu que l’inconvénient principal du système actuel n’est pas son manque d’automatisme, mais plutôt le fait qu’il exige des pays le rétablissement assez rapide de l’équilibre, alors qu’un ajustement plus lent pourrait permettre aux pays industriels en tant que groupe de réaliser plus complètement leurs principaux objectifs. L’auteur soutient que des déséquilibres persistants ont souvent leur origine dans des changements effectués une fois pour toutes et tendent à s’atténuer avec le temps; que le processus d’ajustement peut être renforcé par l’application délibérée de politiques à long terme; et que, si des déséquilibres imposent des pressions insoutenables à certains pays, on devrait avoir recours à des ajustements infréquents de taux de change.

Ajuste de la balanza de pagos entre los países desarrollados


Si es que las restricciones al comercio y a los pagos han de reducirse a un mínimo, es preciso que haya cambios que introduzcan cierto equilibrio en la relación de los precios entre varios países, a no ser que el ajuste se logre principalmente por medio de variaciones en las tasas de crecimiento. En teoría, semejantes modificaciones en los precios podrían surgir automáticamente como consecuencia de tipos de cambio flexibles o de un “ideal gold standard” en un mundo de precios flexibles. La cuestión de cuál ha de ser el nivel de reservas necesario adquiere importancia si los países no se encuentran en disposición de operar un sistema de ajuste totalmente automático.

Por lo general, el ajuste de los desequilibrios no planteó ningún problema grave en el período de la posguerra mientras existían posibilidades de disminuir las restricciones y los aranceles, y había margen para expansión en los países superavitarios; y también mientras las presiones para la pronta rectificación de los desequilibrios quedaban amortiguadas por el esfuerzo que los países realizaban para acumular reservas, así como por la ausencia de preocupación de parte de Estados Unidos ante la mengua de sus reservas. Esto indujo a que se confiara en que el ajuste podría lograrse a través de políticas financieras internas sin perjudicar seriamente los objetivos en cuanto al empleo, el crecimiento, y los precios, y fomentó que se interpretara que el Convenio del Fondo confería un carácter virtualmente fijo a los tipos de cambio. En el sistema actual, sin embargo, resulta difícil lograr cambios que equilibren los niveles de los precios.

Se ha aducido que la mayor desventaja del sistema actual no consiste en una falta de automatismo, sino más bien en el hecho de que exige que los países recobren su equilibrio en un plazo relativamente breve, en tanto que un ajuste más lento quizá permitiría alcanzar más plenamente los objetivos primordiales de las políticas de los países industriales en general. Este trabajo sostiene que a menudo los desequilibrios persistentes obedecen a alteraciones que ocurren de una vez por todas y que los mismos tienden a ceder con el tiempo; que puede darse al proceso de reajuste mayor impulso mediante políticas a largo plazo adoptadas con ese propósito; y que si los desequilibrios imponen presiones insoportables para algún país, deberá recurrirse a ajustes de los tipos de cambio a infrecuentes intervalos.


Miss Romanis, economist in the Special Studies Division, is a graduate of Cambridge University. She was formerly on the staff of the Oxford University Institute of Statistics; the Programmes and Plans Division, Ministry of Production, London; the Economic Directorate, Organization for European Economic Cooperation, Paris; and the Economic Survey Division, United Nations, New York. She has published several articles on economic subjects.


Changes in foreign aid policy will not henceforward be separately referred to throughout the paper, and should be assumed to be included when changes in restrictions upon external transactions are mentioned.


The author is particularly indebted to Mr. M. Kuczynski for comments on this section of the paper.


For a fuller discussion of the system established after the war, see J. Marcus Fleming, “Developments in the International Payments System,” Staff Papers, Vol. X (1963), pp. 461–84.


“. . . many changes will have to be made before the pattern of exchange rates is suited to the radically altered conditions of the postwar world. The great task of the International Monetary Fund is to see that necessary adjustments in exchange rates are made promptly and in an orderly manner and that they are helpful in establishing a new economic balance in a greatly changed world.” (Camille Gutt, “Exchange Rates and the International Monetary Fund,” an address given at Harvard in February 1948, reprinted in Foreign Economic Policy for the United States, ed. Seymour E. Harris (Cambridge, Massachusetts, 1948), p. 219.) Although a change in parity was not an ultimate solution, and needed to be supported by appropriate policies to overcome the underlying causes of disequilibrium, the Fund could not object to such a change because a country was not taking adequate measures to correct its position, if the existing parity was already hampering the growth of exports and encouraging excessive imports and would make it difficult to re-establish equilibrium if appropriate policies were adopted. Ibid., pp. 224–25.


“. . . it appeared to the Fund that for the present the one practical test which could be applied to determine the suitability of an exchange rate was whether it enables a country to export.” Ibid., p. 221.


Notably in the United Kingdom throughout the postwar period, in the United States up to the mid-1950’s, and in Sweden in the later years of the decade.


The fact that investment goods were in short supply on world markets at this time enhanced the possibility of securing a rapid increase in exports by a slight slowing down of domestic investment.


If this condition held, it would of course be virtually impossible for certain developed countries to reach a position of surplus and full employment while other developed countries had deficits and less than full employment.


For instance: “If an implicit goal is a system of fixed exchange rates, what is required is differential rates of inflation between countries; surplus countries should let prices go up while deficit countries should either prevent them from going up or let them fall, depending on how the ‘burden of adjustment’ is agreed to be divided” (Robert A. Mundell, “On the Selection of a Program of Economic Policy with an Application to the Current Situation in the United States,” Banca Nationale del Lavoro, Quarterly Review, No. 66, September 1963, p. 267).


Walter S. Salant has recently suggested (“Does the International Monetary System Need Reform?” reprinted in Money in the International Order, ed. J. Carter Murphy (Dallas, Texas, 1964)) that changes in the relation between price levels of different countries are not entirely ruled out by the criteria of domestic price stability and the maintenance of high employment in both surplus and deficit countries. “A deficit country can reduce its average price level as rapidly as output per man-hour rises without making the real value of aggregate demand too small, if money wages can be kept constant and prices decline at the same rate as output per man-hour increases.” But to assume that all reductions in cost will be passed on to the consumer, when demand is adequate to ensure a high level of employment, implies a perhaps unrealistic degree of self-restraint on the part of both entrepreneurs and wage earners.


Walter S. Salant, op. cit.


The great attraction of the system of flexible exchange rates to its proponents, notably Professor Milton Friedman, lies in its automaticity, and the fact that, ideally, the system could work without the need for decisions on the part of a small number of individuals making it vulnerable to “accidents of personality and shifts of power.” However, as Professor Friedman has to admit, “it is possible for Governments to intervene and try to affect the rate by buying and selling”—a possibility which he naturally considers undesirable. See his evidence in Hearings Before the Joint Economic Committee of the Congress of the United States (88th Congress, First Session, November 12–15, 1963), p. 456. In fact, the assumption that a system of fluctuating rates would work automatically implies deliberate self-denial on the part of those in a position to influence the rate, in face of strong political pressures from various groups against changes in the rate. The relevant question is not so much that of the potential advantages of an automatic adjustment, as of the possibility of achieving these advantages in practice.


See, for example, Robert A. Mundell, “On the Selection of a Program of Economic Policy with an Application to the Current Situation in the United States,” loc. cit., and “The International Disequilibrium System,” Kyklos, Vol. XIV (1961), pp. 153–72; and J. Marcus Fleming, “Domestic Financial Policies Under Fixed and Under Floating Exchange Rates,” Staff Papers, Vol. DC (1962), pp. 369–80.


Robert A. Mundell, “The Appropriate Use of Monetary and Fiscal Policy for Internal and External Stability,” Staff Papers, Vol. IX (1962), pp. 70–79. See also Rudolf R. Rhomberg, “A Model of the Canadian Economy Under Fixed and Fluctuating Exchange Rates,” The Journal of Political Economy, Vol. LXXII (1964), pp. 1–31.


An address in May 1963 on economic progress and the international monetary system, reproduced in the Hearings Before the Joint Economic Committee of the Congress of the United States (88th Congress, First Session, November 12–15, 1963), p. 563.


For a discussion of possibilities of changes in par values under the present system, see Irving S. Friedman, “The International Monetary System: Part I, Mechanism and Operation,” Staff Papers, Vol. X (1963), pp. 219–45.