Bretton Woods System vs The Economic and Monetary Union Emu  Essay

  • Length: 6 pages
  • Sources: 23
  • Subject: Economics
  • Type: Essay
  • Paper: #70344045

Excerpt from Essay :

Rules and Institutions of the Bretton Woods System

The increasing popularity of the importance of monetary unions has gained much focus in the recent past. Most states consider forming monetary unions a solution to most of their financial problems. However, they fail to realize the challenges associated with its establishment and sustainability. Therefore, this research paper analyzes two different monetary unions, their policies, failures and successes and lessons learnt from their experiences for future success of the monetary unions.

The key design features of the System

The system was designed with the fundamental aim of establishing an international financial system to overcome the real and perceived financial problems. Among the problems included the competitive devaluation, subordination of the monetary policy in relation to the external bane and the need for the establishment of a system that facilitated exchange rates for different foreign transactions (Eichengreen, 2004). The design of the system adopted the principle of the flexible link that is related foreign currency to gold, a key determinant that given a fixed exchange rate for the convertibility of transactions in the multilateral payment method. This proved effective as it provided international liquidity and control of the flow of capital. The system provided an obligation to the member states to adopt a financial/monetary policy, which maintained the stability of the exchange rate by linking the currency of exchange to the U.S. dollar (Kenen, 1994).

This strategy provided the IMF with an opportunity to bridge the imbalance of payments attributed to the Second World War. However, the ability of the system to reduce the impact of the member states to influence the decision making of the IMF proved as the weakness of the Bretton Woods Systems. As stated by Eichengreen, (2004), the legislative obligations imposed by the Bretton Woods acted as a key feature that maintained the loyalty of the member states to the agreement. The rules stated that, each of the member states had to pay 25% of their quota to the IMF alongside keeping their exchange rate within the 1% range around their par value. Bretton Woods' institution comprised mainly of the International Monetary Fund and the World Bank. These institutions played a role of bridging the payment imbalances facing the member states (Lucarelli, 2011).

Effectiveness of the Bretton Woods system Basing on its success and failures and lessons learnt

Given the lack of adequate conventional explanations, the significant increase of the international trade in the 1950 s and 60 s provides insights to the need for the evaluation of the effectiveness of the system. The year 1968 witnessed a significant rise in the exports from most countries, which formed the key members of the Bretton Woods System. Apart from this, the world trade improved significantly during this era. This shows a simple correlation between the roles of the system in contributing to the boom of the trading activities globally (Verdun, 2002). However, economic analysts' questions whether the significant increase witnessed globally was attributable to the model or because of macroeconomic stability seen during this period. From an economic point-of-view, the Bretton Woods System lacked full convertibility owing to the restrictions that inhibited the flourishing of the bilateral stage. Economic historians consider such inhibitions as the key underpinning factors that contributed to the fall of the systems during the 1970 s (Wyplosz, 2006).

Critical analysis of the system shows that the system effectiveness was designed to last for twelve years (Welfens, 2001). The prohibition of the member states to restrict current account payments as stated in Article VIII questions the credibility and sustainability of the system. As such, studies from empirical studies depict the Bretton Woods System as an intervention that lacked the ability to foresee the need for adopting strategies that accommodated the dynamic changes in the financial market. It is appreciable that the system came into being after the effects of the Second World War to the big nations such as the U.S., Russia, and Japan. As such, the executives hurriedly embraced the financial restrictions only to find it difficult for the IMF to fund such states. This proved convertibility of the currency more difficult, time and resources consuming to the involved nations, thereby leading to its ultimate demise (Vives, 2001).

The Bretton Woods System designed its rules and institutions without taking into consideration the automatic adjustment facing its member states. In particular, it failed to consider the influences of the delayed adjustments to deflation, and consequences of unemployment. These later resulted in asymmetries between the surpluses of some commodities and deficit that influences the stability of the unit of exchange. According to financial analysts, the system design adopted by the Bretton was dynamically unstable influencing its credibility. As a result, the lack of stability failed to enable the scheme achieve its desired credibility, a key factor in influencing the stability and the sustainability of the program in the market (Verdun, 2002).

Lessons the policymakers learn from the system

From the performance of the Bretton Woods System, it is evident that the history favors incremental steps adopted towards reforming institutions and promoting their success (Va-squez, 2000). In this case, the system signifies an aberration that is unlikely to be emulated by the policy makers. Economic solutions may appear based on sound economic principles, but may face many political constraints within the member countries influencing the realization of the planned goals (Torres, 1996). For example, Bretton was a pure economic agreement, which took little consideration on the political implications to the realization of the desired goals. Thus, it is important for policymakers to view any financial idea from the standpoints of both political and economic platforms as political dimension is always characterized by complicated challenges of variability of the democratic accountability across the states. Nearly all international agreements have numerous technical hitches. This ranges from political, social to economic challenges (Steil, 2013).

Policy makers also learn the importance of joint responsibility doctrine. The doctrine holds a belief that decisions concerning the goals of a policy lie upon the government. When it sets them, the government leaves it to financial institutions to meet the set objectives with a greater sense of autonomy. Therefore, similar principles should be employed in future attempts of creating any international financial infrastructure. It is important to set broad limits for the key participants rather than giving restrictions to adhere to as in the case of the Bretton Woods Systems. This fosters success in the realization of the objectives of any international financial infrastructure (Pisani-Ferry, 2013).

Key Design features of the European Monetary Union EMU

The European Monetary Union EMU refers to the policies developed converge the economies of the European Union members. Among the rules set by the policy makers in the member states, include the obligation to have a stable institution that guarantees democracy, human rights, and protection of minorities (Lucarelli, 2011). It also sets laws stipulating the need for the member states to have a functional market economy. This aimed at enabling them to cope with the increasing pressure from the global competition and adopt a single currency by the all the member states. Empirical research shows that, the introduction of the EMU as a measure for promoting international financial exchange creates significant financial implications to the member states (Kenen, 1994). For instance, the establishment of a single currency translates to the inhibition of independent printing of currency by the member states to pay creditors and reduce the risks of default. The agreement increases the magnitude of responsibility among the member states.

As recognized by James, (2012) the monetary policies reduce the incidences of unhealthy competition between the member states, thereby, providing equal opportunities for the economic growth. When compared to the earlier, the design systems used by the EMU prove more efficacious in ensuring the credibility of its success (International, 2013). Features such as the focus on the euro system, effective development of strategies to co-ordinate macro-policies, establishment of the fiscal compact for responding to financial woes and a single interest rate across the member states attest the success of the UME witnessed in the recent past (Herrmann, 2001). Unlike in the case of the Bretton Woods Systems, the EMU has no institutions held responsible for maintaining economic policy. Instead, the member states are empowered to ensure economic sustainability through the division of responsibilities among each of them (Ha-gele, 2010).

Lessons EMU has learnt or not learnt from the experience of the Bretton Wood Systems

The stability of the EMU is at the center of theoretical analysis, among financial analysts and policy makers (Ehrig, 2010). For this, it proves worthwhile for it to learn from the experiences of other international financial interventions such as the Systems to gain the desired insights to ensure sustainability of its monetary union. Experiences from the model have provided EMU with insights of appreciating the relationship between politics, and economic principles in influencing the success of the international financial venture (Eichengreen, 2004). This understanding provides it with the ability to distinguish between institutional frameworks of sustainability of the…

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