Several readers of earlier drafts of this article deserve acknowledgment for their helpful advice, especially Lorraine M. McDonnell, Stephen D. Krasner and anonymous reviewers for International Organization, John T. Woolley, Haruhiro Fukui, and Mary McKenzie. Richard Clucas provided valuable research assistance.

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The importance of coordination depends on two facts: (1) that there are not enough independent policy instruments available to allow each country to hit all of its macrotargets; and (2) that policy instruments of one economy affect macroeconomic outcomes in others. In these circumstances we can show that a “Nash policy equilibrium”, inwhich each country chooses its preferred policies taking the other countries' actions as given, will be Pareto-suboptimal. Policy coordination, in which all countries agree toadjust their policy instruments away from the Nash equilibrium, can raise welfare everywhere.

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14. From 1960 to 1962, U. S. authorities initiated a number of steps towards a more aggressive defense of the dollar: 1) President Eisenhower early in 1961 made it illegal for U. S. citizens or corporations to hold gold, thus emphasizing the limitation of America's responsibilities in the gold market to purely official dealings. 2) The Federal Reserve Board instructed the New York Fed to begin taking an active role in the foreign exchange markets, working to narrow the gap between forward and spot rates on the dollar and thus diminish the potential gain from speculation. 3) Beginning late in 1960, American monetary authorities changed their interest rate policies, attempting to allow short rates to rise in line with those in other money centers, while holding down long rates to foster domestic investment and recovery from the recession. “Operation Twist” was pursued more aggressively in the Kennedy years, and in 1962 the Federal Reserve's Regulation Q limits on interest rates were eased in general and dropped altogether for foreign official deposits. 4) The administration for the first time began to offer incentivesb to official holders to increase their dollar balances. “Roosa bonds” earned competitive interest, and being denominated in the currency of the holding country, they could be counted as part of the foreign central bank's liquidity base and were guaranteed to retain their worth even if the dollar were devalued.

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16. Roosa's advocacy of a network of bilateral swap arrangements over SDRs is typical: “[Swap agreements] are far preferable, it seems to me, to the often proposed types of action (involving still more difficult decisions and negotiations) that basically involve an oath of allegiance by all governments and central banks to a synthetic currency device, created by an extra-national authority bearing neither the responsibilities nor the disciplines of sovereignty”. Roosa, Robert V., The Dollar and World Liquidity (New York: Random House, 1967)Google Scholar.

17. For instance, looking simply at direct contributions to the balance of payments, in 1960 short-term capital flows—the focus of virtually all the American policy efforts—were $1. 3 billion, while the sum of U. S. military expenditures abroad, government foreign aid and loan programs, and U. S. private direct investment amounted to $7. 6 billion.

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19. In 1965, only the returns from grain sales to the Soviets allowed the Bank of England, supported by the Gold Pool, to match demand and supply. In 1966 and 1967 the supply of new gold declined, and the shortfall was worsened as the June 1967 Middle East conflict stimulated demand. When the pound was devalued in November 1967, it was clear that stabilizing the market would require sizable new contributions to the Gold Pool, while at the same time France publicly announced that it had ceased contributing in June (its share was subsequently covered by the United States). The remaining members of the pool met in late November and agreed to extend standing swap arrangements and concert forward market operations to draw deposits out of gold and into the Eurodollar market. The calming effect on the gold market lasted less than a month.

20. From a few hundred million in 1960, the market had grown to nearly $50 billion by 1970, an amount exceeding the sum of official gold or dollar reserves. Its largest influence was on the most open economies and exaggerated the system's asymmetries, having a net favorable effect on the dollar but producing serious difficulties for economic managers in Britain and Germany. Most observers agreed that the problem was fostered by the growing magnitude, technical sophistication, and volatility of the private market for gold and foreign exchange, but in the liberal international context, this development was consensually beyond the reach of national policy. Indeed, the market served both central banks (which intervened from 1966 to 1968 to dampen interest rate shifts and smooth exchange market fluctuations) and domestic financial institutions (allowing them to avoid restrictions on the growth of lending, thus inhibiting national governments' attempts to control the money supply).

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26. The IMF agreed to monitor the exchanges to assure that national monetary authorities did not buy gold at the official price and then sell it in the private market; and the French and others, who had so persistently opposed the institution of Special Drawing Rights, were forced to accept their expansion, lest further resistance should threaten their acknowledged first priority—maintaining the system's fixed link with gold.

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28. See Gowa, Closing the Gold Window, and the works cited there.

29. Gowa, Closing the Gold Window, chap. 4.

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32. See also Houthakker, Hendrik S., “The Breakdown of Bretton Woods,” in Sichel, Werner, ed., Economic Advice and Executive Policy: Recommendations from Past Members of the Council of Economic Advisors (New York: Praeger, 1978), pp. 87–115Google Scholar; Haberler, Gottfried and Willett, Thomas D., A Strategy for U. S. Balance of Payments Policy (Washington, D. C.: American Enterprise Institute, 1971)Google Scholar; U. S. Congress, oint Economic Committee, Action Now to Strengthen the U. S. Dollar (92d Cong., 1st Sess., 08 1971)Google Scholar.

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39. During the preceding week, the Joint Economic Committee issued its report calling for devaluation, and the Bank of England requested a formal guarantee of the gold value of their dollar holdings (U. S. Congress, Joint Economic Committee, Action Now; U. S. Congress, Joint Economic Committee, The Balance of Payments Mess, 92d Cong., 1st Sess., June 1971). The decision to meet the international monetary crisis by Closing the Gold Window was taken before the Camp David meeting, when the president and Connally, already committed to controls, had envisioned a September start date for the program. Integrating the two into a broad-gauge policy package was attractive because it responded in one dramatic political gesture to critics of the administration's domestic economic management and to the attack on the dollar from overseas. See also DeMarchi, Neil, “The First Nixon Administration: Prelude to Controls,” in Goodwin, Craufurd D., ed., Exhortation and Controls: The Search for a Wage-Price Policy 1945–1971 (Washington, D. C.: Brookings Institution, 1975), pp. 295–352Google Scholar; Cameron, “How the U. S. Got on the Road”.

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41. McCracken pointed out to the president that, based on the experience of other countries, controls would lose their effectiveness the longer they were in force, and they would be followed by an explosive “catch up” period which would cause a temporary jump in the inflation rate. Given that ending convertibility would increase the uncertainty in an already volatile international financial situation, and that the uncertainty would be compounded the heavier the speculative pressure on the dollar, convertibility should be ended at the beginning of the controls period (when inflation was falling), rather than later, when the dollar would be under even more severe pressure and the controls instrument would have been exhausted. Gowa, , Closing the Gold Window, p. 170Google Scholar.

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50. See also Nixon RN; Stein, “The Council of Economic Advisors”; Shultz, George P. and Dam, Kenneth W., Economic Policy Behind the Headlines (Stanford, Calif.: Stanford Alumni Association, 1977)Google Scholar.

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54. A grain shortage produced an additional shock at the same time, causing unexpected food price rises in 1973 and 1974 (quarterly averages for 1972 through 1975 are: 5. 5%, 16. 3%, 12. 5%, 6. 2%). Estimates of the effect on consumer prices vary from 4 to 5. 7 percent from fourth quarter 1972 to fourth quarter 1974. (Eckstein, Great Recession, chap. 6; Blinder, Great Stagflation, chap. 4; Hathaway, Dale E., “Food Prices and Inflation,” Brookings Papers on Economic Activity 1 (1974), pp. 63–116CrossRefGoogle Scholar. The effects of these two supply shocks were essentially identical in kind, although they differed in magnitude, so that they can be treated together for our purposes. See also Perry, George L., “Determinants of Wage Inflation Around the World,” Brookings Papers on Economic Activity 2 (1975), pp. 403–48CrossRefGoogle Scholar; Pierce, James L. and Enzler, Jared J., “The Effects of External Inflationary Shocks,” Brookings Papers on Economic Activity 1 (1974), pp. 13–54CrossRefGoogle Scholar; Eckstein, The Great Recession, chap. 9.

55. See also Hibbs, Douglas A. Jr, “Political Parties and Macroeconomic Policy,” American Political Science Review 71 (12 1977), pp. 1467–87CrossRefGoogle Scholar; Hibbs, , “The Mass Public and Macroeconomic Policy: The Dynamics of Public Opinion toward Unemployment and Inflation,” American Journal of Political Science 23 (11 1979), pp. 705–31CrossRefGoogle Scholar.

56. Whitman, “Current and Future Role of the Dollar”.

57. Theoretically, fixed real wages also imply that falling demand should be matched by declining wage rates, so that employment and inflation are held steady. But in practice an economy with fixed real wages is the natural counterpart to a polity with strong labor support for left parties, so that political constraints assure that the real wage is ratcheted against declines. See Cameron, David, “The Expansion of the Public Economy: A Comparative Analysis,” American Political Science Review 72 (December 1978), pp. 1243–61CrossRefGoogle Scholar. Because the supply shock drove energy prices sharply upward, the overall inflation rate could be maintained only if political authorities were willing to implement contractionary stabilization policy. Since union economic and political power can prevent a fall in the wage rate, such a deflationary policy must produce a recession and a rise in unemployment. This, in brief, is the dilemma elites faced in most advanced European economies. In spite of such high domestic political costs, their sensitivity to balance-of-payments constraints forced European governments to adopt partially extinguishing responses to the oil shock. The depth of the resulting recession helps to explain the failure of European economies to receover as quickly as the United States after 1975.

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62. By early fall of 1974, GNP had declined for three successive quarters (see U. S. Bureau of Economic Analysis, Survey of Current Business, 1974), so that the indicators of recession were quite clear, and the public's perception of the nation's primary economic problem had shifted sharply from inflation to recession. See also Hibbs, “Mass Public and Macroeconomic Policy”.

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64. See The Economist, 1 December 1973; 12 January 1974; 26 January 1974; 1 June 1974; 29 June 1974; New York Times, 25 August 1974.

65. The administration was not unaware of these arguments: the weighing of domestic as against international claims was a considered one. See, for instance, W. Fellner/CEA memo to President Ford, “International Financial Conditions”, 4 October 1974 (Ford Presidential Library, White House Central Files/Business and Economics), describing “deepening worldwide concern”.

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69. Blinder and Goldfeld, “New Measures.”

70. The president and his advisors were sensitive to the possibility of recession but more concerned to quell price rises, and advisors consistently gave less emphasis to early indicators of cyclical downturn than to those tracking the inflation side of the supply shocks' effects. See for instance, the CEA's evaluation of trends in retail sales, inventories, and wholesale and retail price indexes (A. Greenspan/CEA to President Ford, 17 September 1974; 24 September 1974; W. Fellner/CEA, 10 October 1974; 11 October 1974); predictions of the economic outlook for 1975 (A. Greenspan/CEA to President Ford, 26 November 1974); or concern about excessive monetary growth (W. Fellner/CEA to President Ford, 14 December 1974) (Ford Presidential Library, WHCF, CEA files). See also President Ford's remarkably Eisenhower-like speech against inflation, in an economic address to the Congress in October 1974 (Public Papers of the President, 1974).

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74. Bruno and Sachs, Economics of Worldwide Stagflation; Oudiz and Sachs, “Macroeconomic Policy Coordination.”

75. Keohane, “Foreign Economic Policies”; “Theory of Hegemonic Stability.”

76. See Odell, International Monetary Policy; Gowa, Closing the Gold Window, on the monetary case; Oudiz and Sachs, “Macroeconomic Policy Coordination,” on the supply shock; and see Stewart, Age of Interdependence; Cooper, “Economic Interdependence”; Putnam and Bayne, Hanging Together.

77. Ruggie, John Gerard, “International Regimes, Transactions, and Change: Embedded Liberalism in the Post-War Order,” in Krasner, Stephen D., ed., International Regimes (Ithaca, N.Y.: Cornell University Press, 1983), pp. 195–232Google Scholar; Rohrlich, Paul Egon, “The Concept of Economic Culture,” International Organization 41 (Winter 1987), pp. 61–92CrossRefGoogle Scholar.

78. See Axelrod, Robert and Keohane, Robert O., “Achieving Cooperation under Anarchy: Strategies and Institutions,” World Politics 38 (October 1985), pp. 226–54CrossRefGoogle Scholar.

79. Keohane, Robert O., After Hegemony: Cooperation and Discord in the World Political Economy (Princeton, N. J.: Princeton University Press, 1984)Google Scholar

80. See Steinbrunner, John D., The Cybernetic Theory of Decision (Princeton, N. J.: Princeton University Press, 1973)Google Scholar.