Peter M. Garber

Bretton Woods Ii Still Defines the International Monetary System

In this paper we argue that net capital inflows to the United States did not cause the financial crisis that now engulfs the world economy. A crisis caused by such flows has been widely predicted but that crisis has not occurred. Indeed, the international monetary system still operates in the way described by the Bretton Woods II framework and is likely to continue to do so. Failure to properly identify the causes of the current crisis risks a rise in protectionism that could intensify and prolong the decline in economic activity around the world.

Will Sub-Prime be a Twin Crisis for the United States?

We identify incentives generated by the Bretton Woods II system that may have contributed to the sub-prime liquidity crisis now working its way through the international monetary system. We then evaluate the persistent conjecture that the liquidity crisis is or will become a balance of payments crisis for the United States. Given that it happens, the additional costs associated with a sudden stop of net capital flows to the United States could be quite substantial. But we observe that emerging market governments have continued to acquire US assets even as yields have fallen, and the incentives for continuing to do so remain strong. Moreover, the Bretton Woods II system, which has clearly been the most resilient of the forces driving current markets, continues to generate low real interest rates in industrial countries and growth in emerging markets that will help limit the damage from the liquidity crisis.

Notes on Market-Based Bank Regulation

Although Basel capital regulations have focused a great deal of senior management attention on the management of on- and off- balance-sheet risks, there still remains the moral hazard offered by the ability of bank owners to ride on underpriced deposit insurance. In its current form, capital regulation tends to encourage an increase in the riskiness of bank assets held on balance sheet, the spin off of low-risk assets, and movements into less burdened off-balance-sheet activity. In sum, the safety net still provides an incentive to misprice risk.