International Monetary PolicyAn effective world economy requires an effective monetary system, for monetary relations affect all international transactions. The basic objective of our international monetary policy parallels that of our overall foreign policy-to work with others to build a stable system free from crises. The continued improvement in international monetary cooperation in the past few years helped make 1970 a year of relative tranquility in the monetary system, in contrast to the recurrent monetary crises which punctuated the 1960s.
The size of the United States in the world economy and the dollar's key role in the international monetary system levy a special responsibility upon us. We must manage our own economy responsibly for international as well as domestic reasons. Inflation or contraction in this country has a disruptive effect on the rest of the world economy. We intend to meet this responsibility.
In 1970 we made solid progress toward restoring stability as well as growth in the U.S. economy. Our economic policies moderated the rate of domestic inflation. Our trade surplus improved, providing a more satisfactory structure for our balance of payments. We expect to reduce inflation still further in 1971, even as our economy begins to expand again at a more satisfactory pace.
U.S. interest rates have also receded greatly from the record highs of a year ago, while interest rates in other countries have declined more gradually. We therefore no longer exert the strong pull on capital from other countries which contributed to sizable surpluses in our balance of payments on the official reserve transactions basis in 1968 and 1969; instead, a sharp reversal of short-term capital movements has temporarily but sharply increased the underlying deficit in our payments position. The continued strength of international cooperation has helped to absorb these shifts without serious impact on the monetary system, but the potential reoccurrence of such rapid and large-scale movements of funds, along with the U.S. deficit, pose important issues for the future.
Cooperation in the monetary sphere has three major objectives: to assure an adequate growth in the supply of international money; to improve the means for adjusting payments imbalances and thus relating nations' economies to one another; to handle large-scale shifts of liquid capital without exchange crises or losses in the ability of individual nations to pursue their own monetary policies.
The first objective means assuring satisfactory growth in the supply of internationally acceptable money and credit which is needed for financing payments imbalances among countries. An inadequate rise of such reserves can lead governments to deflate their economies unnecessarily to protect their own reserves or, more likely, to take restrictive measures which directly depress the flow of trade and investment transactions. Excesses of world reserves, in contrast, can permit deficit countries to delay too long the steps needed to correct their payments imbalances, and impart a tendency toward inflationary pressures in surplus countries as a result.
Part of the easing of tensions in the monetary system in 1970 can be attributed to the decision in 1969 to create a new form of reserve asset-Special Drawing Rights (SDRs) at the International Monetary Fund-a step I called "of profound importance" in last year's report. In 1970 member countries of the IMF joined to take the historic step of creating $3.4 billion of this truly international money. Another $2.9 billion of SDRs were created on January 1 of this year, and a like amount will also be created in January 1972.
Even in their first year of existence, SDRs have won widespread acceptance as an integral part of the monetary system. They have been used extensively by some countries to help finance their payments imbalances. The United States both accepted and paid out SDRs to finance its payments position in 1970, and will continue to do so in the future as our payments situation requires. We look forward to further growth in SDRs, and to their further use by all countries. We look forward to the day when this product of remarkable international cooperation will become the primary reserve asset in the international monetary system.
We also welcome the sizable increase in IMF quotas decided upon in 1970. They will provide an increased pool of temporary financing for international payments imbalances. Most importantly, the quota increases-together with the SDRs-further enhance the position of the IMF at the center of the international monetary system, demonstrating the successful role which can be played by an international institution in a field where worldwide cooperation is a prerequisite for progress.
There was also some progress last year toward the second objective of international monetary cooperation-to improve the means by which widely diverse national economies can adjust to each other. Payments imbalances can be financed only temporarily; we need a constructive and orderly means of making more lasting rectifications -without forcing countries to resort to restrictions on international transactions, or to excessive inflation or unemployment at home.
An effective international adjustment process begins with effective economic policies in each country. Sound economies must then be soundly related to one another. Improved procedures by which orderly exchange-rate adjustments can contribute to this process would promote stability in the monetary system and help prevent the kind of crises that punctuated the l960s. Canada's temporary freeing of its exchange rate in May 1970 demonstrated the potential utility of such a mechanism but also emphasized the question of whether there is a need for new international rules to govern its usage.
The international financial community wisely took advantage of the relative calm of 1970 to make an important advance toward an international consensus on such an improved mechanism. The Executive Directors of the IMF issued a report on the role of exchange rates which recognized that, within the broad context of stability in exchange rate relationships, more flexible techniques and practices could help improve the adjustment process and thus the international monetary system as a whole. Three possible improvements were singled out: a widening of the margins within which exchange rates could fluctuate around their par values, more frequent and thereby smaller changes in parities themselves, and temporary use of floating exchange rates, with appropriate safeguards, to effect transitions from one par value to another. We welcome continued work in this area by the IMF and other bodies, with particular attention to the possible need for amendments to the IMF Articles of Agreement to achieve the needed evolutionary improvements in the present system.
Finally, the massive shifts of short-term capital in recent years have drawn attention to a third dimension of international monetary relations. It has become clear that very large amounts of money can be attracted to any major country whose money and credit markets are tighter than the comparable markets in the rest of the world. We need an intensive examination to determine whether there is a need to reinforce the present techniques and procedures of international monetary cooperation to enable us better to cope with such movements.