The International Disequilibrium System

The International Disequilibrium System

The International Disequilibrium System

The International Disequilibrium System
The International Disequilibrium System
1961

“One of the undisputed foundations of international monetary analysis. Academics take it for granted. Policy-makers ignore it at their peril.” Andrew K. Rose

“Mundell’s principle explicitly delineates the tradeoffs facing central banks in the most sweeping sense.”

The fundamental proposition of classical international trade theory, that there is an automatic mechanism ensuring balance-of-payments equilibrium, enabled the classical economists to isolate the short-run, dynamic process of international adjustment from the long-run, static theory of international barter. To this analytical separation we owe many of the important theorems that have come down to us from classical economics, and on it is based a good deal of modern international trade theory. This is despite the fact that the history of international economic relations in the past 30 years has not been characterized by a persistent tendency toward balance-of-payments equilibrium; the assumption of automaticity now appears to be an anachronism.

The decline of automaticity dates from the first attempts of central banks to adjust the domestic supply of notes to accord with the needs of trade (the banking principle) instead of the requirements of external equilibrium (the bullionist principle); and although these attempts have their origin far back in history, the abandonment of the bullionist principle became widespread only after the revolution in Federal Reserve policy during the 1920’s, and especially after legal or de facto recognition in post–World War II years of full employment as a primary goal of public policy.

The basic instrument of the adjustment process (monetary policy) was for several years diverted away from its original function toward the new requirement of internal balance, and no new weapon had developed to cope with the balance of payments. The absence of an adjustment mechanism implies a policy vacuum that gives rise to the international disequilibrium system, the theory of which forms the subject of this paper.