America's success in stabilizing its own price level after 1949 became the anchor for Western European and Japanese price-level stability. Under the Marshall Plan and the European Payments Union (instituted in September 1950), Western European countries fixed their exchange rates exactly against the dollar. Then only their central banks cleared payments multilaterally among European countries: the beginning of European Monetary Unification. In 1958, the EPU was dissolved in favor of a more open system based on the IMF's Article IV where each member country retained its central dollar parity but allowed market exchange rates to vary within 1 percent of that parity. The clearing of foreign exchange payments then devolved from central banks to commercial banks—with only occasional interventions by central banks to maintain central parities. With capital controls in the other industrial countries and the IMF controlling exchange rate movements, hot money flows were minimal. Thus in the early postwar period, the Fed could focus on purely domestic economic indicators such as inflation or output growth and benignly neglect the rest of the world. Unfortunately, this insularity remained embedded in American monetary policy in the decades to come, even after advancing globalization had made it obsolete.
Keywords: nominal anchor; Marshall Plan; International Monetary Fund; benign neglect; Triffin Dilemma; gold window
Chapter. 5225 words. Illustrated.
Subjects: Financial Markets
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