Maintaining and restoring Balance in International Payments

[Front Matter and Foreword]: The front matter and foreword introduce a symposium on maintaining and restoring balance in international payments. Jonkheer E. van Lennep, Chairman of Working Party No. 3 of the OECD, explains the collaboration between government officials and academic economists to bridge the gap between practicable policy adjustments and ideal theoretical approaches, particularly following the Group of Ten's suggestion that liquidity cannot be discussed in isolation from adjustment policies. [Preface: The Story Behind the Symposium]: Fritz Machlup details the history of the joint conferences between official experts and academic economists that led to this volume. He describes the parallel efforts of the 'group of deputies' from the Group of Ten and the unofficial 'Bellagio Group' of academics to study international monetary arrangements. The preface emphasizes the value of informal workshops in clarifying theoretical issues and political constraints regarding the adjustment process and the creation of international reserve assets. [The Contributors and Table of Contents]: A list of the fourteen distinguished academic contributors and the table of contents for the volume. The book is divided into Part I, containing comprehensive papers by Fellner, Machlup, and Triffin, and Part II, featuring fourteen papers on special issues ranging from exchange-rate flexibility to the impact of adjustment on developing countries. [Chapter 1: Introduction]: The editors provide an overview of the seventeen papers, highlighting the convergence of views among the three comprehensive papers in Part I. They discuss the variety of causes for payments imbalances and the corresponding responses, such as financing, aggregate-demand adjustment, or exchange-rate changes. The introduction defines 'fundamental disequilibrium' operationally and notes the general academic leaning toward greater exchange-rate flexibility through mechanisms like the 'wider band' and 'crawling peg.' [Chapter 2: Rules of the Game, Vintage 1966]: William Fellner explores principles for improving the balance-of-payments adjustment process within the Bretton Woods framework. He distinguishes between reserve movements that require reversal and those that do not, advocating for close international collaboration on diagnosis. Fellner defines fundamental disequilibrium operationally as a situation where countries cannot agree on sufficient aggregate-demand adjustments, necessitating structural changes like exchange-rate readjustments. He warns against the use of direct controls and suggests that changing the mix of monetary and fiscal policy can help avoid discriminatory measures. [Chapter 3: In Search of Guides for Policy (Sections 1-3)]: Fritz Machlup seeks objective criteria to guide balance-of-payments policy, focusing on prognosis, diagnosis, and therapy. He proposes an 'early-warning system' based on the rate of money creation relative to real GNP growth. Machlup analyzes the difficulty of locating the source of disturbances and emphasizes that adjustment is 'simple' only when it involves aggregate demand without irreversible wage increases. He discusses the trade-offs in the timing of remedial measures, noting that fast adjustment of cost-price disparities under fixed exchange rates often requires politically unpalatable levels of unemployment or inflation. [Choosing between Financial Correctives and Real Adjustment]: This section examines the choice between 'real' adjustment (changing the flow of goods and services) and 'financial' correctives (adapting the flow of funds). It contrasts the classical preference for real adjustment, based on efficient international capital allocation, with nonclassical views that favor managing capital flows to avoid the painful price and income changes associated with real adjustment. The authors express skepticism regarding the ultimate effectiveness of financial correctives, noting that restrictions on specific capital outflows are often offset by changes in other capital items or unintended repercussions in the trade balance. [Choosing Between Real Correctives and Real Adjustment]: The authors distinguish between 'real adjustment' (automatic or non-discriminatory policy-driven processes) and 'real correctives' (selective or discriminatory measures like tariffs and quotas). Real adjustment operates through price/income changes or exchange rate variations, maintaining or potentially increasing trade volume. In contrast, real correctives like import barriers are criticized for being restrictive, uneconomical, and prone to retaliation. The section concludes that general adjustment is superior to selective correctives on grounds of equity and efficiency, though officials often prefer piecemeal correctives to avoid the political visibility of devaluation. [Choosing between Aggregate-Demand and Exchange-Rate Adjustment]: This section compares two methods of real adjustment: altering aggregate demand (deflation/inflation) versus altering exchange rates (devaluation/upvaluation). While theorists often view exchange-rate adjustment as less wasteful than demand deflation, practitioners frequently resist it until a 'fundamental disequilibrium' occurs. The authors argue that the current system of 'adjusting the peg' often results in delayed and excessive devaluations. They emphasize that devaluation is not a substitute for monetary restraint; it cannot cure a deficit if domestic credit expansion remains excessive. [Choosing between Fiscal and Monetary Adjustments of Demand]: The authors analyze the 'policy mix' approach, where fiscal policy manages domestic demand (internal balance) and monetary policy manages the international flow of funds (external balance) via interest rates. While this can provide short-term relief, especially against speculative capital outflows, the authors doubt its long-run efficacy in curing fundamental disequilibria. They note that the mix required for deficit countries (fiscal ease and monetary stringency) may be injurious to long-term economic growth by restricting investment in favor of consumption. [Choosing between Exchange-Rate Adjustment and Direct Controls]: This section critiques the use of direct controls (on trade and capital) as a substitute for adjustment. The authors argue that using restrictions to defend fixed exchange rates is logically inconsistent, as the purpose of fixed rates is to enlarge international trade, which restrictions inherently curtail. They characterize prolonged controls as a 'perversion of thought' and suggest that if demand adjustment is too harsh, exchange-rate adjustment is the only genuine alternative for a country seeking to promote foreign economic relations. [Judging the Priorities of Conflicting Objectives]: The authors discuss the difficulty of balancing multiple conflicting objectives: external balance, full employment, price stability, and growth. They argue that because countries often have incompatible 'program balances' (e.g., everyone wanting a surplus), the pursuit of specific balance-of-payments structures leads to harmful selective measures. The section concludes that since national determination to prevent imbalances is often weak, a system of continuous international surveillance and consultation is needed to harmonize monetary policies. [The Balance-of-Payments Seesaw (Robert Triffin)]: Robert Triffin introduces the 'seesaw' analogy to describe the shared responsibility between surplus and deficit countries. He argues that internal and external policy aims converge when aggregate demand is set to absorb productive potential minus/plus sustainable capital flows. Triffin emphasizes the role of monetary reserves as the link between independent currencies and highlights the 'deflationary bias' of the current system, which places more pressure on deficit countries. He calls for institutional reforms to ensure adequate growth in world reserves and better coordination of national targets. [Diagnosis of Disturbances and Remedial Prescriptions]: This section outlines criteria for diagnosing international payment disturbances and prescribes remedial policies. It introduces external indicators like reserve movements and price-competitiveness, alongside internal indicators such as wage movements and liquidity financing. The text distinguishes between imbalances caused by aggregate demand excesses and those rooted in structural competitiveness disparities, suggesting specific policy responses for each. [Statistical Framework and Source Diagnosis]: Footnote 9 providing bibliographic references for the statistical framework of monetary and income analysis, citing works by the author and Herbert Grubel regarding OEEC countries and the EEC. [Remedial Policies for Demand and Competitiveness]: Detailed analysis of remedial techniques for addressing imbalances in aggregate demand and competitiveness. It discusses the 'moral' burden of adjustment between surplus and deficit countries and the role of interest-rate policy. The section highlights Robert Mundell's work on the 'mix' of monetary and fiscal instruments and suggests that compensatory official assistance or temporary capital controls may be necessary to manage reversible capital movements. [External Financing, Restrictions, and International Compatibility]: Explores the role of external financing in avoiding unnecessary structural adjustments to temporary imbalances. It argues that trade and exchange restrictions are generally inappropriate remedies for undercompetitiveness or inflation. The section concludes Part I by emphasizing that international coordination is the only acceptable alternative to the lost 19th-century laissez-faire mechanism in an era of government intervention. [Chapter 5: On Limited Exchange-rate Flexibility]: William Fellner presents a statement signed by twenty-seven economists advocating for two reforms: widening the exchange rate band (margin flexibility) and allowing small, unilateral annual parity shifts (shiftable-parity). Fellner argues that fixed rates are incompatible with modern money-wage rigidities and full employment goals. He analyzes the stabilizing role of speculation, the risks of unlimited flexibility, and how limited flexibility reduces the need for international reserves while providing clearer signals for responsible national policy. [Chapter 6: Adjustment, Employment, and Growth]: Gottfried Haberler examines the trade-offs between balance-of-payments adjustment, employment, and long-run growth. He critiques the 'soft' school of Keynesianism, arguing that occasional recessions and avoiding 'over-full' employment can actually maximize long-term growth by dampening the wage push and preventing brittleness in the economy. Haberler rejects the 'adjustable peg' system in favor of limited flexibility, citing historical examples like the 1949 sterling devaluation and the 1961 German appreciation to show that fixed-rate adjustments are usually too late and too large. [Chapter 7: The Speed of Adjustment]: Sir Roy Harrod argues that the appropriate speed of adjustment depends on the cause of imbalance. While demand inflation requires quick deflation, cost-push and structural imbalances require slow-working remedies like 'incomes policy' or small exchange-rate changes. He warns against pre-Keynesian codes of conduct that might force deflation on underemployed economies. Harrod emphasizes the need for high international liquidity to support slow adjustment and discusses the dangers of precautionary capital flights under the adjustable-peg system. [Chapter 8: The Objectives of Economic Policy and the Mix of Fiscal and Monetary Policy]: Harry G. Johnson analyzes the differential effects of fiscal and monetary policy on the balance of payments. He argues that because fiscal expansion raises interest rates (improving the capital account) while monetary expansion lowers them, a specific 'mix' can achieve both internal employment and external balance targets. The section extends this to a global 'n-country' system, discussing the mathematical consistency of policy objectives and Mundell's principle of effective market classification regarding the dynamic stability of policy assignments. [Chapter 9: Financing and Adjustment: The Carrot and the Stick]: Peter B. Kenen argues that international liquidity (financing) and balance-of-payments adjustment should be viewed as complements rather than rivals. He challenges the orthodox view that easy access to reserves encourages procrastination, suggesting instead that the rate of reserve creation should govern the pace and quality of adjustment once a program is initiated. Kenen highlights the welfare costs of rapid adjustment, such as unemployment or destructive trade controls, and advocates for conditional access to reserves ('the carrot') to incentivize slow but sustainable progress toward external balance. [Chapter 10: Limitations of Monetary and Fiscal Policy]: Alexandre Lamfalussy examines the institutional and political constraints that limit the effectiveness of the fiscal-monetary policy mix in achieving simultaneous internal and external balance. He identifies several key limitations: government preferences for specific balance-of-payments structures, political inability to implement restrictive fiscal policies, destabilizing market expectations that offset interest-rate differentials, and rigid or 'irrational' asset preferences among financial intermediaries. The essay concludes that while theoretically sound, the policy mix is often hampered by these practical constraints in a regime of fixed exchange rates. [Chapter 11: Money Rates of Interest, Real Rates of Interest, and Capital Movements]: Friedrich A. Lutz analyzes how differing rates of price inflation across countries distort international capital movements under fixed exchange rates. He argues that capital does not necessarily move toward the highest real marginal efficiency of capital because money interest rates fail to accurately reflect inflation components. This discrepancy makes interest-rate policy an ineffective tool for controlling capital flows without causing domestic economic disaster. Lutz concludes that these distortions provide a strong argument for either a stable world price level or the adoption of floating exchange rates. [Chapter 12: The Capital Account in the Balance of Payments]: Fritz Machlup provides a theoretical framework for interpreting international private capital flows, distinguishing between autonomous disturbances, official settlements, market-induced counterflows, and policy-induced correctives. He explains how these different types of movements interact with the automatic adjustment mechanism. Machlup emphasizes that while official financing can nullify the adjustment process if neutralized by internal credit expansion, private counterflows triggered by market forces are more likely to initiate real adjustment by altering domestic spending and relative prices. [Chapter 13: Wage-and-Price Guideposts in the Context of Balance-of-Payments Adjustment]: Jürgen Niehans discusses the role of wage-and-price guideposts as a tool for balance-of-payments adjustment. Guideposts aim to improve the trade-off between employment and price stability by keeping increases below market-driven levels. Niehans examines the difficulties in determining effective formulas (such as productivity-linked wages) and the conditions under which they are effective, such as in monopolistic markets or during boom periods. He concludes that guideposts are temporary expedients that may be appropriate for deficit countries seeking to improve their current account without increasing unemployment, but they cannot replace fundamental adjustment measures. [Chapter 14: Capital Markets and the Balance of Payments of a Financial Center]: Walter S. Salant explores the hypothesis that the U.S. balance-of-payments deficit is a reflection of its role as a global financial intermediary. He argues that a financial center naturally runs a liquidity deficit by providing long-term capital and liquid assets to other regions (like Western Europe) that have higher liquidity preferences or less efficient capital markets. Salant critiques the standard 'liquidity' definition of a deficit, suggesting that such imbalances are consistent with equilibrium growth. He warns that restricting U.S. capital outflows could harm European growth and that the current international monetary system's focus on these deficits may be misplaced. [Chapter 15: Alternative Methods of Restoring Balance]: Tibor Scitovsky argues for a more cooperative approach to international payments adjustment, involving both surplus and deficit countries. He critiques the over-reliance on restrictive monetary and fiscal policies in deficit countries. Scitovsky reviews alternative methods, including exchange-rate adjustments and various forms of controls (market-based and administrative). He specifically suggests that temporary import liberalization by surplus countries and tariff surcharges by deficit countries under international agreement could be more efficient and less burdensome than current unilateral practices. [Chapter 16: Adjustment Responsibilities of Surplus and Deficit Countries]: James Tobin examines the conditions necessary for maintaining fixed exchange parities among developed nations, assuming a de facto fixity beyond the original Bretton Woods intent. He argues that compatibility in economic objectives, instruments, and institutions is essential, yet difficult to achieve due to the inherent conflict between full employment and price stability. Tobin suggests that adjustment obligations should be defined by a country's specific economic circumstances (unemployment and inflation rates) relative to group targets, rather than by assigning 'blame' for imbalances. He proposes a schematic code (Tables 1 and 2) to coordinate fiscal and monetary policy responses and financial rights between surplus and deficit countries. [Chapter 17: A Statistical Framework for Monetary and Income Analysis]: Robert Triffin provides a formal statistical framework linking monetary accounting identities to Gross National Product (GNP) analysis. He defines 'credit monetization' and uses the 'monetary ratio' (the inverse of income velocity) to demonstrate how expansionary impulses are absorbed by real production growth, price increases, or current-account deficits. The framework is designed to diagnose whether economic disturbances stem from capital-account issues, aggregate demand imbalances, or cost-competitiveness disparities. Triffin emphasizes that while these equations are tautological, they clarify the necessary conditions for compatibility between policy instruments and targets. [Chapter 18: Impact of the Adjustment Process on Developing Countries]: Robert L. West analyzes how the adjustment processes negotiated within the Group of Ten (G-10) impact developing nations. He argues that the G-10 does not function as a closed system; its members' trade and financial links with non-members create an asymmetrical 'twist' effect. For instance, nondiscriminatory adjustment policies in industrial deficit countries can inadvertently induce contractionary disturbances in the developing world. West highlights the uneven dependence of developing nations on specific G-10 markets (like the US and UK) and calls for explicit safeguards and inclusive 'rules of the game' to protect the growth and stability of less developed economies during international monetary reforms. [The Adjustment Process in Developing Countries]: This section examines the unique challenges developing countries face in the international adjustment process. It argues that standard policy instruments used by industrial nations, such as interest rate adjustments to influence capital flows, are often ineffective in developing economies due to inflexible fiscal systems and rigid development plans. The text describes a model where booms and contractions in industrial nations are transmitted to developing countries with intensified effects due to elasticities in export prices and the cyclical availability of foreign capital. Consequently, developing nations often face a conflict between internal growth objectives and external balance, necessitating a different mix of international trade and aid measures. [Notes on Terminology]: A comprehensive glossary of terms used throughout the symposium to ensure clarity and consistency. It provides technical definitions for various types of payment imbalances (official-settlements, liquidity, and basic-transactions), distinguishes between 'adjustment' (automatic or policy-induced market reactions) and 'correctives' (selective impacts on specific sectors), and explains concepts like 'offsetting' and 'fundamental disequilibrium'. The section also clarifies the distinctions between monetary and fiscal policies and provides nuanced interpretations of 'inflation' and 'structural change' in the context of international payments. [Index]: A detailed alphabetical index of subjects, concepts, and authors mentioned throughout the volume 'Maintaining and Restoring Balance in International Payments'. It includes page references for key topics such as the Group of Ten, exchange-rate adjustments, liquidity, and various economic thinkers like Keynes, Triffin, and Machlup.