Chapter 14: Problem 4

Discuss the philosophy and operation of the Bretton Woods system of adjustable pegged exchange rates.

Short Answer

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Bretton Woods system was a post-World War II arrangement for managing the international monetary system. Its philosophy was to promote international cooperation, stabilize exchange rates and support economic growth. It operated by pegging member countries' currencies to gold, maintaining exchange rate bands and allowing periodic adjustments with IMF assistance. It ended in 1971 when the US ended dollar's gold convertibility.

Step by step solution

Introduction to Bretton Woods system

The Bretton Woods system, named after the location of the meeting where the agreement was signed in 1944, was an arrangement for managing the global monetary system. Its main components were rules for commercial and financial relations among industrial states and the creation of international institutions such as the IMF and World Bank. This formed a system where exchange rates among currencies were pegged but adjustable.

Philosophy of Bretton Woods system

The philosophy behind the Bretton Woods system was to promote international monetary cooperation, stabilize currency exchange rates, and facilitate international trade. The system was designed to prevent competitive devaluations and promote economic growth.

Operation of Bretton Woods system

Each member country agreed to set its currency’s value in terms of gold and was obligated to maintain exchange rates within a margin of 1% above or below the pegged rate. When a country found itself in an 'economic disequilibrium', it could alter its peg within this band. The IMF provided short-term economic assistance for countries to correct balance of payment problems.

Conclusion on Bretton Woods system

The Bretton Woods system was in effect until 1971 when the United States unilaterally terminated convertibility of the dollars to gold, effectively ending the system and marking the start of the era of floating exchange rates that exists today. From its philosophy to its operation, the Bretton Woods system played a significant role in shaping the global economic landscape of the 20th century.

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