This essay discusses the instruments available to central banks for stabilising nancial systems in the face of international capital mobility. These instruments are control of the money supply and credit availability, the short-term rate of interest, and open market operations. None of these instruments can be more than temporarily effective and, with nancial innovation and inflation, they are less capable of independent use. The essay explains that these instruments are powerless against nancial instability because world nancial systems are divided into two mutually incompatible monetary systems: those based on a government bond standard; and those based on a foreign currency reserve standard.

Introduction

Emerging market crises since the 1990s have highlighted the role of international capital movements as mechanisms bringing about nancial inflation and then, by the withdrawal of that capital, triggering the collapse of vulnerable markets. At the root of all this is a distribution of productive capital around the world that does not match the distribution of expenditure. Therefore the national units or currency areas, across which cross-border expenditure or capital flows take place, rarely have balanced cross-border expenditures or capital flows but tend to suffer from chronic de cits or surpluses.1 In the Bretton Woods era before 1971, limited nancing of de cits was available through the of ces of the International Monetary Fund.