How Lessons from 1944 Bretton Woods Apply to Pandemic Recovery

September 01, 2021

This 17-minute podcast was released Sept. 1, 2021.

Paulina Restrepo-Echavarria, senior economist

“It's important in certain situations to protect capital flight, to protect crisis or prevent them in other countries in order to guarantee stronger growth in the long run for everyone,” says Paulina Restrepo-Echavarria, senior economist at the Federal Reserve Bank of St. Louis. She talks with Maria Hasenstab, media relations coordinator at the St. Louis Fed, about how the post-World War II Bretton Woods agreement applies to life in 2021.



Maria Hasenstab: Welcome to Timely Topics, a podcast series by the St. Louis Fed. I am Maria Hasenstab, your host for this episode, and with me today is Paulina Restrepo-Echavarria, senior economist at the Federal Reserve Bank of St. Louis. Paulina, thanks for joining us today.

Paulina Restrepo-Echavarria: Thank you very much for having me.

Hasenstab: Paulina, you joined us for a Timely Topics podcast a couple years ago where you discussed Bretton Woods. I know you've been doing ongoing research on that topic. And today, we're going to dig a little bit deeper into the Bretton Woods Agreement: What did we learn from it, why would the U.S. agree to it, and what can we apply from Bretton Woods to life today in the year 2021.

To start, Paulina, give us a brief recap of the Bretton Woods Agreement.

Restrepo-Echavarria: Okay. So, we're standing in 1946 and World War II has just ended, but policy makers are pretty pessimistic and uncertain about what's going to come in the next 10 years, specifically because they weren't sure if labor markets were going to be able to absorb all the labor force increase that was going to come from all the men and women participating in the war. And this was due to the uncertainty in this peak of economy recovery or the ability to recover from the war. So, that's, on the one hand, the gloomy view they had about the future. And then, there were a lot of fears of the same episodes that occurred between World War I and World War II occurring again. So, more specifically, during those years, we know that they experienced the market crash of 1929, and so, there was a lot of uncertainty about the ability of markets to self-regulate and work properly. But at the same time, they weren't thrilled either about governments dictating unilaterally what policies were to be implemented, in the sense that, between the two wars, a lot of governments implemented unilateral decisions in order to devaluate exchange rates and take advantage of trade agreements or they implemented quotas as well.

So, we are in a situation where the two main designers-let's say like that-of the Bretton Woods Agreement were Harry Dexter White on the behalf of the U.S. and (John Maynard) Keynes on the behalf of Europe. They wanted to come up with policy that could control markets or regulate markets, on the one hand, and also control how much governments could decide unilaterally in order to avoid the situations that I mentioned earlier. So, what they came up with, what resulted in the Bretton Woods Agreement, which basically stated that there was going to be one currency of reference and then all other exchange rates with respect to that currency were going to be fixed, and the currency of reference was going to be pegged to gold.

In order to be able to implement this policy, they also needed to impose impediments to international capital mobility in order to be able to maintain these fixed exchange rates. So, they decided to create, from an institutional perspective, the International Monetary Fund and what we know today as the World Bank, and the World Bank was in charge, basically, of transferring resources to Europe in order to facilitate the reconstruction. And the IMF was in charge of preventing speculative capital flight. And so, what this means is that, for all the countries participating in the agreement, which were 44 countries, and they needed to maintain their exchange rates relative to the dollar fixed, they needed to impose this international capital mobility controls in order to do that. And so, they were not going implement those controls independently or unilaterally, but they always had to do it through the IMF. So, the IMF was in charge of controlling speculative capital flows by allowing or helping out countries implement the necessary policies to have these impediments to international capital mobility such that they could fix or maintain those fixed exchange rates.

In a nutshell, what we have is this very big agreement where 44 countries participated. The main aim was to guarantee economic stability and to be able to guarantee, as much as possible, the economic growth and the absorption of all the increase in the labor force that they thought that they were going to see happening in the next years.

Hasenstab: Paulina, you've categorized Bretton Woods as a huge economic experiment. Talk to me about what have we learned from Bretton Woods.

Restrepo-Echavarria: So, what we find in our research, specifically my research, we, Lee Ohanian, Mark Wright, and Diana Van Patten is that actually the U.S. was the big loser in terms of welfare when it came to the agreement. So, in other words, if we divide the world in three regions, so think about the world as divided between the U.S., western Europe, and then the rest of the world where the rest of the world is mostly constituted of the Asian tigers, Latin America, Canada, Australia, and New Zealand, we see that, when, when using our models, we can calculate the welfare gains or welfare losses that the three regions suffered. And what we find is actually that the U.S. had a welfare loss of around 4.4%in terms of consumption equivalent, and this is a pretty loss. And Europe and the rest of the world had gains.

So, in other words, the U.S. was the big loser from the Bretton Woods Agreement, and this is arising because why did the U.S. want to do this in the first place because, when the agreement was negotiated, the U.S. was the country that had the most bargaining power. The agreement was mostly negotiated between Harry Dexter White on behalf of the U.S. and John Maynard Keynes on the behalf of Europe, and the U.S. basically had the power to decide what they wanted to do, so much so that Keynes had proposed a new currency as the currency of reference. So, they did not want, or he did not want the U.S dollar to be a currency of reference within the agreement. He proposed some new currency that was supposed to be called the bancor, and at the end of the day, the U.S. had the ability to decide. And Harry Dexter White said, "No. We're not creating this new currency called the “bancor.” The U.S. dollar is going to be the currency of reference." That's how it going to be done, basically.

So, they had the power to decide how things were implemented, and even though that was the case, we still saw that they were the big losers from the agreement. So, the big question that arises from our research is why did the U.S. want this? How come this ended up being the case? Was it a situation where they couldn't really foresee that they were going to be losing the agreement? Was it a surprise? Or were they very aware of the fact that they were going to be giving up consumption with respect to the rest of the world and they were okay with it?

Hasenstab: So, why would the U.S. enter into that agreement?

Restrepo-Echavarria: So, we were very surprised by the result. Right? So, when we go back and look at history, what we find and what we've read is basically that the U.S. was willing to pay to prevent capital flight and crisis. So, basically, we interpret our findings as an estimate of the perceived value of capital controls, which was supporting a broader, more expensive international policy agenda. And what was this policy agenda? Well, they were interested in several things. First, they were interested in promoting ally reconstruction after the war. They were also interested in least developing countries' growth and supporting friendly governments.

On the other hand, we had a situation where they wanted to really prevent hostiles, specifically Nazis at first and Soviets later, from influencing other countries, specifically Latin America. They thought that Latin America was at a great risk of being influenced by Nazis. And so, they wanted to prevent these political influences on this region. And so, the U.S. viewed international capital markets as very prone to crisis. We know that crises drain capital. They depress growth. They create political instability, and so, they thought they needed this control to keep capital in these countries because they knew, that if they kept capital in these countries, that was going to help their economic situation and they were going to be way less prone to crisis. And they thought this was the right thing to do.

Hasenstab: So, it's really interesting that you've said that the U.S. had the biggest influence on this agreement and yet they're categorized as the biggest loser. Let's talk about those losses. Did the U.S. know going into the agreement the extent of the losses it would face?

Restrepo-Echavarria: I don't know if they knew the extent, but from what I just said, I think that it's clear that they could anticipate that they would probably lose from the agreement, and they were okay with that. They were okay with losing as long as capital would stay in the countries that it was supposed to stay. They were okay with losing if that meant that Nazis were not going to have a big influence in Latin America and if this meant that they would minimize the chances of capital drains associated with economic crisis, with depressed growth and political instability. So, they wanted to prevent all of that, and they seemed to know that that was the case.

Hasenstab: They thought the gains were worth the losses?

Restrepo-Echavarria: That's what we think so. We think that they did anticipate that. That's what they were going for.

Hasenstab: Now, I want to think about what can we apply from Bretton Woods Agreement to today, life in 2021. I've heard you describe some of these gains and losses, the way America acted going into this agreement almost as the U.S. taking one for the team.

Restrepo-Echavarria: Yes, absolutely. In our previous discussions, I've mentioned that. I think that the U.S. was taking one for the team. Exactly. That's what they were doing.

Hasenstab: That was life in 1946, when the U.S. and the entire world were recovering from the Second World War, and now, it's 2021 and the U.S. and the entire world are at various stages of recovery from the COVID-19 pandemic. What can we learn from Bretton Woods that might apply to life today?

Restrepo-Echavarria: So, I think that there's a lot to learn, actually, from Bretton Woods about the situation we're living in today. We are at a point where we're supposed to be getting out of the pandemic, but I think this is true in the developed world. In general, the U.S. and Europe are doing much better than the rest of the world. Unfortunately, Africa and Latin America are in a really bad situation still in terms of the numbers for the virus, and something that is very important is that I don't think that we're going to be able to fully overcome the pandemic as long as the pandemic is really present in certain areas of the world, so specifically developing countries, because the virus and the pandemic goes hand in hand with the economic situation, with economic growth. When the pandemic hit, we entered a huge recession. It was a worldwide recession, basically, and now that the pandemic, pandemic is easing out and the numbers have gone down, we know that we've seen economic growth again.

But then, we are in a situation where the developed world has vaccines, plenty of them, so much so that, specifically here in the U.S. we've reached the point where no more people want to be vaccinated and there is extra vaccines going around. Europe is still in the process of vaccinating everyone, but they've made huge improvements. But it's reaching a point where the people that want to get vaccinated are who they are, and the rest of the world has no vaccines or very little vaccines or they're being very inefficient about them and so on. So, the problem is the economic recovery will start to diverge greatly between the developed world and developing countries. In what sense? Because we know that the U.S. economy is picking up. We know that we're growing pretty fast and that we're actually starting to see some inflation happening. And up to now, our interest rates are still in the zero-lower bound.

But what happens if the U.S. keeps seeing this increasing inflation? What happens if our interest rates have to go up? What happens if market forces cause our interest rates to go up? Now, the rest of the world is going to be in a situation where capital flight is a very real scenario and imagine how concerning it would be for emerging markets to be in a situation where they have not been able to overcome the virus because they cannot vaccinate enough people. They don't have the vaccines or the means to do it, and at the same time, interest rates in the rest of the world go up. They start having huge capital flights such that their economy suffers even more than what they were suffering from the virus. So, I think that we're in a situation where this would be actually, in my view, kind of catastrophic for emerging markets.

And so, I think that we are at that point where, again, we should ask whether the developed world, specifically the U.S. and Europe, if they want to see this situation happening or they want to do something about it. Because, at the end of the day, they are going to be two consequences that they're going to have to experience firsthand. One thing is the virus itself. If we don't get the virus under control in the developing world, then variants of the virus, as we've been seeing already happening, are going to start developing and they're going to come back to the U.S. And then, we don't really know how vaccines are going to act against those. So, there's a very real possibility of the virus coming back and the pandemic not ending. And then, from an economic standpoint, if those countries cannot get their act together, the pandemic is still present and after, you know, even on top of that, they start getting huge capital flights to the U.S., or Europe for that matter, although I see it more likely to the U.S., then their economies are going to suffer even more. So, we're going to have the rest of the world in a huge economic crisis and following the one that we've already been seeing in the past year and a half, they won't be able to recover. And so, this will inevitably also affect the U.S.

My view on this is that the U.S. should actually be really forward-looking, and we should be doing more in order to try to help emerging markets and developing countries to control the pandemic through vaccines and support in the vaccination process and so on, such that if interest rates were to go up here, we don't see huge capital flights from these economies into the U.S., which at the end will generate huge global imbalances, which won't be good for anyone in the long run.

Hasenstab: In closing, what do you want our listeners to take away from the Bretton Woods Agreement and what we've learned from it?

Restrepo-Echavarria: So, I think that it's important that sometimes we need to support each other. So, countries need to support each other in economic terms because we live in a globalized world. Whatever happens in the rest of the world will affect us as well in economic terms. It's important in certain situations to protect capital flight, to protect crisis or prevent them, in other countries in order to guarantee stronger growth in the long run for everyone.

Hasenstab: Paulina, thank you so much. You have given us a lot to think about especially in terms of history.

For more of Paulina's work, please visit the St. Louis Fed's website at

You can find all of our Timely Topics podcasts on the St. Louis Fed's website, Apple Podcasts, Spotify, or wherever you listen to your podcasts.

Paulina, thanks so much for your time today.

Restrepo-Echavarria: Thank you, Maria. It was very interesting talking to you.

Economists and experts talk about their research, topics in the news and issues related to the Fed. Views expressed are not necessarily those of the St. Louis Fed or the Federal Reserve System.

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