Question

Critically discuss whether the Bretton Woods System has been based on Keynesian principles. Please give me main arguments for my essay . Thank you!

Answer 1

Classical economists believe that in the long run, economy achieves its potential. There can be short term shocks to Economy which are cyclical but economy adjusts in the long run.

In this case, as shown in the diagram below, Aggregate demand is shifting to left, then according monetarists, average price level will come down from p1 to p2, real GDP also goes down from Y1 to Y2.

Monetarists believe that as economy is having slowdown then wages go down and costs of production also go down. As firms have low costs they increase short run aggregate supply (SRAS) and as SRAS shifts to right, economy comes back to equilibrium at LRAS with new price level.

Initially economy was at point a with price level p1 and GDP level Y , whenAD shifted left, average prices go down to p2 and real GDP to Y2, new equilibrium is at point b, but as SRAS shifts right, economy is back at LRAS with new price level P3 and equilibrium at c

Keynes believes that wages are sticky and costs may not go down hence economy shifts to Y3 at price levels P1 only and is stuck there. Unless government invests huge amount of money to close this gap of Y1-Y3 , economy will be stuck in the short run and will not come back to potential output of LRAS unless govt. puts investments.

This is the main argument by Keynes that when economies have recessions, it cannot come out on its own and needs major investments by government. Same arguments were given during great depressions and a new deal was introduced in USA.

Bretton woods system that has both IMF and World bank were established to mitigate financial emergencies and to provide aid to needy countries so that economic pressures and political unrest can be controlled.

It can be said that IMF and World bank do intervene in financial emergencies and also provide economic guidelines while giving aid/ loans. Keynes theory is considered but there is no direct involvement in policy making and it is up to individual countries to implement policies.