The historical experience of the last century provides a testing
ground for the hypotheses that cycles in exchange rate regimes may be
predicted in terms of the `rules-versus-discretion' theory of monetary
policy. The classical gold standard was temporarily disrupted by World
War I, and it was later abandoned at a time of unprecedented economic
and financial instability. That was followed by beggar-thy-neighbour
trade policies and further instability. Fixed exchange rates were
re-established after World War II, but they broke down with the Vietnam
war and the oil shock. They are now being pursued again in Europe, both
within and outside the Community.
In Discussion Paper No. 661, Programme Director Alberto Giovannini
considers the establishment and experience of the Bretton Woods regime
and compares it with its predecessors, in particular the classical gold
standard, to assess the view that countries resort to floating rates as
a temporary response to large shocks to the world economy but then
revert to fixed rates. According to the rules-versus-discretion theory,
fixed exchange rates provide valuable commitments to national monetary
authorities, which governments will abandon by invoking `escape clauses'
only when large exogenous shocks make `tying the hands' of their
monetary authorities too onerous.
Giovannini notes two main difficulties in applying this theory to the
history of the international monetary system. First, it may not apply to
a fiat currency system such as Bretton Woods, under which banknotes were
not convertible into gold and monetary authorities were not required to
intervene in the gold market. Second, the historical records of the
establishment of the Bretton Woods institutions indicate that
policy-makers then sought to substitute more flexible monetary policy
coordination for the fixed convertibility rules of the gold standard.
This compromise, which probably resulted from the UK's resistance to
codification of disciplinary rules, indicates that the return to fixed
rates did not re-establish the dominance of rules over discretion.
Giovannini examines the behaviour of interest and exchange rates under
the gold standard and Bretton Woods, and he finds that the official
parities were not credible at times of large shocks, although the very
narrow gold standard bands helped to keep European interest rates within
narrow margins for many years. The statistical evidence on the
credibility of monetary rules under either regime or whether one was
more credible than the other is ambiguous. Credible monetary rules may
be valuable, but the post- war return to fixed rates was not inspired by
any desire to reinstate them: inter-war experience made the return to
gold anachronistic and impractical, but the alternative constructed by
the creators of the IMF lacked credibility.
Bretton Woods and its Precursors: Rules versus Discretion in the
History of International Monetary Regimes
Discussion Paper No. 661, June 1992 (IM)