The Twilight of Bretton Woods
The Bretton Woods vision of balancing free trade and controlled capital flows has facilitated decades of economic integration and peaceful coexistence. But amid growing debt burdens, heightened geopolitical tensions, and rising protectionism, the foundations of that model are breaking down.
Giancarlo Corsetti
FLORENCE – This year’s annual spring meetings of the International Monetary Fund and the World Bank began with quiet fears that US President Donald Trump’s administration would seek to fatally undermine them.
They ended with both institutions being sternly rebuked by US Treasury Secretary Scott Bessent for their increasing concern with climate change and diversity, but also with a sigh of relief that they had survived to fight for development another day.
It is hard to imagine the post-World War II era without the Bretton Woods institutions: the World Bank, the IMF, and the planned – but never operational – International Trade Organization, which became an intellectual precursor to the World Trade Organization.
Within the geopolitical constraints of the time, Bretton Woods laid the foundations for multilateralism in three critical areas: the international monetary system; official lending for reconstruction and development; and economic and financial integration through gradual liberalization of cross-border trade and investment.
These efforts fueled economic recovery in war-affected countries and contributed to decades of relative peace and integration.
But the Bretton Woods institutions were far from perfect.
Within a few years, financial and economic shifts challenged many of their original goals, requiring continuous adjustment.
Still, the core principles underpinning the postwar order were never abandoned – until recently.
For decades, the global economy was shaped by Bretton Woods thinking, which emphasized the pursuit of real growth and stability through multilateral cooperation.
Today, however, that vision is increasingly under attack by politicians and voters around the world. What happened to break the prevailing consensus?
The Evolution of an Order
It is useful to trace the evolution of the global economy during the Bretton Woods era along two main axes: the expansion of free trade in goods and services, and the shift toward greater capital mobility, often accompanied by domestic deregulation.
This evolution is illustrated in the figure below, which charts the progress and setbacks of the global economy over the past century.
The turmoil of the interwar period – represented in the figure’s upper-left quadrant and marked by conflict-driven economic and financial fragmentation – strongly shaped the intellectual consensus behind Bretton Woods.
At the time, international capital flows were widely regarded as a destabilizing force.
Economic integration was considered essential for prosperity and growth, especially in light of the damaging tariff wars of the previous decades.
With this in mind, the Bretton Woods system was initially designed to promote trade liberalization and foreign direct investment while deliberately restricting capital mobility and preventing currency wars.
Exchange rates were pegged to the US dollar, which was anchored by gold.
To be sure, the system was not without flaws.
Its adjustment mechanisms for external imbalances were highly asymmetric, placing most of the burden on deficit countries.
But although trade liberalization was slower than would have been ideal, the strategy proved effective.
Even so, skepticism toward capital mobility and flexible exchange rates persisted for decades.
The original Bretton Woods system (Bretton Woods Mark I) remained intact until the 1970s, when rising inflation and growing imbalances fueled by US wars and OPEC oil shocks rendered it politically and economically unsustainable.
In response, the system was reformed to reflect the new reality, granting countries greater freedom to choose their exchange-rate regimes.
Financial Globalization Goes Awry
The updated Bretton Woods framework ushered in a new era of financial-market development, as flexible exchange rates drove cross-border capital liberalization and domestic deregulation.
As the figure’s middle-right quadrant shows, the global economy shifted toward greater openness, facilitating the rise of market-oriented financial intermediaries that broke from the traditional banking model.
Meanwhile, trade liberalization accelerated following the establishment of the WTO in 1995.
But as the financial sector’s share of GDP expanded, cross-border capital flows soon outpaced trade flows in volume and impact.
By the 1990s, the so-called Washington Consensus had come to define the intellectual, political, and institutional landscape of a new era of unfettered globalization (represented in the figure’s lower-right corner).
While multilateralism was not abandoned, global markets – seen as self-regulating and capable of allocating resources efficiently – increasingly superseded governments across many domains.
The belief in self-regulating markets was only partly shaken by that decade’s financial crises in Mexico, Asia, and Russia, which exposed the vulnerability of emerging economies to liquidity shocks and volatile capital flows.
These crises also reignited the debate over capital controls as a tool for reducing exposure to such risks.
The Washington Consensus posed a serious challenge to the Bretton Woods institutions.
In the new intellectual climate, many began questioning whether the World Bank was truly better suited than capital markets to select development projects.
At the same time, the IMF’s assistance programs were increasingly viewed as too small to help anyone but the world’s poorest countries.
It is also worth recalling that the IMF voluntarily downsized in the early 2000s.
Given its limited resources, turning to the Fund for support was often seen as more costly than insuring against external shocks by accumulating foreign-exchange reserves.
Between 1990 and 2022, for a large sample of countries with available data, median reserve holdings rose from under 5% to over 10% of GDP; these percentages double for the top 75th percentile of the distribution of reserve holdings.
But the spirit of Bretton Woods returned with a vengeance during the 2008-09 global financial crisis, which showed that in an age of hyper-globalization, even advanced economies were not immune to market volatility.
Governments reasserted control over national and international stabilization efforts, extending liquidity lifelines to domestic and foreign banks – often through swap lines.
As policymakers began rewriting financial rules at the national and international levels, they rediscovered the merits of capital controls, whether explicit or embedded in macroprudential frameworks.
Meanwhile, the IMF significantly expanded both the scope and scale of its programs.
During the 2010-12 eurozone crisis, it took on a new role: complementing regional financing mechanisms.
It coordinated closely with the European Union’s newly established regional funds, which operated under markedly different standards and quickly exceeded the lending capacity of the IMF itself.
Contrary to many analysts’ expectations, the 2008-09 crisis and the subsequent shocks did not trigger a protectionist tsunami.
Open trade proved resilient – though not without controversy.
For decades before the crisis, technological advances and declining trade costs had accelerated the relocation of manufacturing to low-cost regions and reorganized global production into complex supply chains, setting the stage for a political backlash against free trade.
From the financial crisis through the mid-2010s, the global economy temporarily returned to the original spirit of Bretton Woods – a phase illustrated in the middle quadrant of the figure.
Trade liberalization was largely preserved, while financial markets and capital flows were somewhat restrained.
Importantly, the 2008-09 crisis made it clear that markets do not self-regulate and cannot guarantee economic stability.
But although multilateralism endured, its foundations began to show visible cracks.
Bretton Woods Unravels
The shift away from the Bretton Woods approach became evident in 2016, as populist political movements began capitalizing on growing discontent with free trade, blaming it for the deterioration of living standards, particularly in the US.
Tariffs were back on the agenda as governments sought to reassert control over domestic economies.
As the middle-left quadrant of the figure shows, the Bretton Woods framework was effectively turned on its head.
While free capital mobility remained relatively unchallenged, trade was increasingly constrained, marking the beginning of the end of Bretton Woods – both in spirit and in practice.
Borders were back, enforced by steep tariffs or the threat that new trade barriers could be erected at any moment.
These developments raise a fundamental question: Is this emerging regime sustainable, given that geopolitical tensions are undermining multilateralism not just between rival blocs but also among longstanding allies?
To assess its durability, we must examine the forces driving today’s protectionist shift.
First, the surge in public and private debt worldwide may tempt governments to resort to financial repression – restricting capital flows to keep domestic savings within national borders.
Mounting concerns over debt sustainability could ultimately steer the global economic system back toward the figure’s upper-left quadrant.
The second force is monetary policy.
From the 1990s onward, most developed economies – and many dynamic emerging markets – embraced inflation targeting alongside trade and financial liberalization.
While limited exchange-rate flexibility remained common among commodity exporters seeking to establish credible fiscal and monetary governance, inflation targeting by independent central banks quickly emerged as the new gold standard for achieving macroeconomic stability.
This reflected the prevailing view among economists that inflation targeting is preferable to the strategic use of monetary tools, which not only impose costs on other countries but also risk undermining domestic stability.
In this sense, the post-1990 monetary-policy regime contributed to global stability by ensuring that central banks remained focused on putting their own house in order.
But can the cooperative model of global monetary policy survive in an age of geopolitical fragmentation?
Will central banks remain independent and maintain their commitment to price stability above all?
The answers will depend on the frameworks adopted to govern the interplay between fiscal and monetary policy in an increasingly conflictual world.
Lastly, technological advances and rising market concentration have made a handful of tech firms immensely powerful.
While these companies are expected to oppose restrictions on trade and capital flows, they also have the means to shape public discourse and political decision-making, potentially determining which restrictions are adopted and how they are implemented.
Similarly, strong national borders could, in theory, coexist with a structured, globalized layer above them, dominated by major economic and political powers colluding to influence domestic politics.
That is why – despite suffering some losses from the overall deterioration in business conditions – large corporations might not put up much resistance to measures that deepen economic fragmentation.
The economists who helped shape Bretton Woods envisioned a system where free trade could thrive alongside capital controls.
Yet a few decades later, tensions within the system led to widespread capital-account liberalization, departing from the system’s original goals.
With Trump-led political backlash against free trade triggering a chaotic turn toward protectionism, it is unclear whether a regime of free capital mobility can remain stable.
If not, then the question becomes how to prevent the global economy from drifting even further toward fragmentation and financial repression.
Such an outcome is not inevitable.
And yet, without coordinated international action, that is precisely where we are headed.
Giancarlo Corsetti is Pierre Werner Chair at the Robert Schuman Centre and Professor of Economics at the European University Institute.
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