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2.16 Keynes and International Macroeconomics

Although Keynes is widely recognized as the economist who more than any

other helped to create macroeconomics, according to Vines (2003), the final

volume of Robert Skidelsky’s magnificent biography of Keynes makes it

clear that he also played a key role in the development of modern international

macroeconomics. In 1945 the international economic system was in a

complete shambles and it has taken over 50 years to rebuild the global

economic system. In July 1944 representatives from 45 countries met at

Bretton Woods in New Hampshire, USA, to discuss the post-war establishment

of major international institutions whose purpose would be to facilitate

international cooperation and increasing international economic integration

and development, thereby improving the stability of the world economy. A

major concern of the Bretton Woods delegates was to help prevent a recurrence

of the disastrous events and consequences of economic mismanagement

that had occurred during the interwar years. The outcome of the meeting was

the creation of what John Maynard Keynes labelled the ‘Bretton Woods

twins’, the International Monetary Fund (IMF) and the International Bank for

Reconstruction and Development (IBRD), now known as the World Bank.

While the main objective of the World Bank is to focus on long-term economic

development and poverty reduction issues, the main objective of the

IMF, as originally set out in its Articles of Agreement (Charter), is the shortrun

stabilization of the international monetary system. In December 1945, the

IMF officially came into existence when 29 countries joined, and it finally

began financial operations on 1 March 1947. The World Bank began formal

operations on 25 June 1946. In addition, the General Agreement on Tariffs

and Trade (GATT) was established in 1947, with the main purpose to promote

trade liberalization by encouraging and facilitating the lowering of trade

barriers. In a series of eight negotiating rounds before the current Doha

Round, GATT succeeded in significantly cutting tariffs and reducing other

barriers to trade. The GATT was never established as a formal institution but

was set up as an interim device which would operate until the establishment

of an international trade organization (ITO). In 1995 this was finally achieved

with the establishment of the World Trade Organization (WTO).

Skidelsky describes Keynes as a ‘joint author’, along with Harry Dexter

White, of the Bretton Woods international monetary system. Vines (2003,

p. 339) goes further and argues that Keynes ‘came to an extraordinary clear

understanding of how pieces of the global economy interact, driven by

policies of autonomous nations’. Keynes’s work on British war finance and

his quest to ‘save Britain from financial ruin at the hands of the US at the

end of the war’ pushed him towards a sophisticated understanding of the

emerging post-war international economic system. By 1945 Britain’s economic

and financial position was catastrophic. In response to this crisis

Keynes’s work during the last few years of his life created international

macroeconomics and this contribution is ‘as important as any of Keynes’s

achievements as an economist’ (Vines, 2003, p. 339). Keynes’s wartime

work builds on his earlier contributions to international finance contained

in Indian Currency and Finance (1913), A Tract on Monetary Reform

(1923), The Economic Consequences of the Peace (1919), The Economic

Consequences of Mr. Churchill (1925), and A Treatise on Money (1930).

Unlike the General Theory, which has a closed economy setting, Keynes’s

earlier work highlighted the workings of the international monetary system.

Vines goes so far as to claim that ‘Keynes invented’ the two-country version

of what later became the Mundell–Fleming IS–LM–BP model (see

Chapter 3, section 3.5).

Keynes’s extraordinary vision of the emerging shape of the international

economic system had already crystallized by 1944. Vines relates a personal

discussion he had with Nobel Memorial Laureate James Meade in which

Meade recalled witnessing Keynes sketching out ‘on the back of an envelope’

something similar to Table 2.2 as his vision of the future.

Table 2.2 Keynes and the international economic system, 1944

Objective Instruments Responsible authority

Full employment Demand management National governments

(mainly fiscal)

Balance of payments Pegged but adjustable International Monetary

adjustment exchange rates Fund

Promotion of Tariff reductions etc. International Trade

international trade Organization

Economic development Official international World Bank


Source: Vines (2003).

While the GATT rather than an international trade organization was established

in 1947, the vision contained in Table 2.2 is a remarkably accurate

picture of what came to be known as the ‘Bretton Woods system’.