The consolidation of economic liberalism

A new wave of economic liberalism emerged at the end of the 1960s and took a leading position after the dollar devaluation of 1971. The theoretical underpinnings of this change hail from the clash between the desirability of achieving traditional domestic goals and the need to satisfy financial stability and the external objective of financeable balances. As to practical implications for the international institutions, free trade tended to emerge as the dominant credo, facilitated by successive rounds of tariff cuts.

The underlying reason for liberalization is twofold. First, in the absence of a common commitment to pursue full employment, countries inevitably try to reach their own goals of higher income and growth by beggar-thy-neighbor export-led policies, thus creating pressure for a movement to complete free trade. Second, the support for free capital flows was instead the outcome of the growth of the financial sector, and the need for investment and the higher bargaining power of creditor countries. Progressive differentiation between the positions of various countries then led to the adoption of floating exchange rates.

The era of managed-flexible-exchange rates started de facto in 1971 and officially became the “new regime” in January 1976. At a meeting of IMF members in Jamaica, the articles of agreement of the IMF were amended to recognize flexible exchange rate systems. After that, member nations could adopt an arrangement of their own choice.

The following sections examine the evolution of the international monetary regime in the post Bretton Woods era. Section 12.1 deals with the features of the new system based on floating exchange rates. Section 12.2 illustrates how the flexible exchange rate regime works. Section 12.3 describes the evolution the IMF to this new regime.

Section 12.4 deals with the role played by free capital movements and other pro-market policies promoted by international institutions. In this period, a system – now collectively known as the Washington Consensus – operated to deal with imbalances in their members’ economies.

We then move to the international financial crisis from a systemic point of view. Section 12.5 analyzes the evolution of international payments imbalances that have produced a number of financial crises and threatened financial stability and real activity in the developed and emerging market economies.