Capital Flows, External Debt and the International Adjustment Process

Abstract

Under the Bretton Woods System, one of the major concerns was that the supply of international reserves would be increasingly inadequate. At the macro- or international level, the shortage would prove deflationary and lead to both declines in the world price level and restrictions on international trade and payments; at the country level, the shortage might lead to excessively abrupt adjustments in exchange rates and exchange controls. In the 1960s, especially toward the end of the decade, many analysts believed that because international reserves were inadequate the speed of adjustment to payments imbalances would be too rapid and so excessively costly. The view was that if international reserves had been larger or had increased more rapidly countries with payment deficits would be able to adjust at a less rapid pace, and so their costs of adjustment would have been smaller. Moreover, more of the burden of adjustment would have fallen on the surplus countries. The argument is that the costs of adjustment to payments imbalances vary with the speed of adjustment to the new balance of payments equilibrium. For each distribution of imbalances there is an optimal speed of adjustment. That adjustments must be made to restore payments equilibrium is generally recognised, except in those cases when the disturbance is temporary, and the return to the pre-disturbance equilibrium ‘automatic’.