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The Consequences of Bretton Woods' International Capital Controls and the High Value of Geopolitical Stability

This paper quantifies the positive and normative effects of international capital controls on global and regional economic activity under The Bretton Woods international financial system and thereafter. A three region, open economy, DSGE capital flows accounting framework consisting of the U.S., Western Europe, and the Rest of the World, is developed to identify capital controls and quantify their impact. We find these controls had large positive and normative effects by restricting international capital flows. Counterfactual analyses show world output would have been 0.6% higher had there been perfect capital mobility, and that these impediments to capital mobility raised welfare substantially in the rest of the world and modestly in Europe, at the expense of much lower welfare in the U.S. This finding raises the key question of why the U.S. promoted these controls within the system? We interpret the large U.S. welfare loss as an estimate of the implicit value to the U.S. of keeping capital in ally and developing countries, and thus promoting global political stability within these countries, including European and Latin American countries. This interpretation is consistent with the literature from that time that emphasized the U.S.'s interests in supporting U.S. -friendly governments in the face of communism and fascism.

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