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Unit 5: Exchange Rate Systems
Part 3: The Bretton Woods
Modified Gold Standard
The modified gold standard
after the Bretton Woods agreement aimed was designed to
take advantage of the virtues of both fixed and floating
exchange rates. The relative stability of a gold-backed
system was needed to bring nations out of the isolationism
that characterized the interwar period. But the exchange
rates were meant to changeable: in the event of a fundamental
disequilibrium, the gold parity rates could be modified.
The Bretton Woods system led to a specific kind of policy
impasse, sometimes called the “trilemma”
of the system. (A trilemma is like a dilemma, except there
are three choices [tri-] rather than two.) The trilemma
was that nations could choose any two of the following three,
but could not have the third at any given time:
In the early years of the Bretton Woods system, many countries
maintained policy independence, but did so at the cost of
restricting investment flows. As trade increased and the need
for capital mobility grew, it was necessary for these countries
to give up fiscal and monetary policy independence and to
target exchange rates as their policy focus. Over time (see
part 1), the very size of the interventions needed to make
a difference dwarfed most governments’ abilities. Initially,
in reaction to these pressures, the Bretton Woods system was
modified—with exchange parities being redefined—but
eventually the exchange rates anchored to gold through the
dollar had to be abandoned.
Ultimately, then, the reason for Bretton Woods’ failure
was quite familiar: whatever value the stability of this system
brought to international markets was overshadowed by the loss
of sovereignty over domestic policy, which it required.
VIDEO: The Ineffectiveness
of Monetary Policy under Fixed Rate Systems
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