ing the International Monetary Fund (IMF) lend to its member countries? At a somewhat abstract level, I would suggest that it could be defined as that of easing the external constraint on its member countries to the extent that such an easing can be expected to be advantageous to the world community as a whole. It follows immediately that the eas- ing has to be of the external constraint pro- vided by liquidity rather than solvency, since at best, an easing of the solvency constraint involves a resource transfer that will leave the donors worse off, while at worst, a belief in endogeneity of the solvency constraint creates moral hazard problems that under- mine the incentive for economic efficiency. Hence, my conception of the principle that should be guiding the Fund's lending policies is that they ease the external liquidity con- straint to the degree that is generally ad- vantageous while preserving the intertem-

The title of my paper implies the following five claims: 1) It is possible for macroeconomic policy to influence exchange rates in a substantive way; 2) It is desirable that macroeconomic policy target the exchange rate; 3) It is nevertheless desirable to leave substantial latitude for exchange rates to fluctuate around their target levels; 4) The target should be a real rather than nominal exchange rate; 5) The real value of the dollar was broadly appropriate when this paper was written (December 1988). The paper is devoted to explaining the basis for these five propositions.

The essence of the regime of unmanaged floating that prevailed among the major currencies from March 1973 until the Plaza Agreement in 1985 was that the exchange rate was treated as a residual in the process of macroeconomic policy determination. Admittedly there were occasions-such as October 1976 in the case of the pound sterling and October 1978 in the cases of both the U.S. dollar and the Swiss franc-when particular countries became so concerned with a misalignment of their currency that they were forced to abandon benign (or malign) neglect, but such incidents were episodic. Views about a proper or desirable level of the exchange rate played no systematic role in policy formulation. Section I explains why I judge the performance of unmanaged floating to have been unsatisfactory. Section II lists the real social benefits that exchange rate flexibility can afford, which should be preserved by any reformed system. Section III describes the target zone proposal and explains why it would preserve the real benefits of flexibility while overcoming the weaknesses of unmanaged floating. Section IV sketches a possible set of comprehensive principles for policy coordination of which target zones would be one natural element.

It has become customary to look back with nostalgia at the golden age when the Bretton Woods system held sway, from the early 1950's to around 1970. It also seems to be the conventional wisdom, however, that the rules of Bretton Woods contributed little to the impressive performance of the world economy over that period-a performance characterized not merely by the fastest and most widely distributed growth in history, but also by notable stability, including near price stability except at the beginning and end of the period. The deterioration in the performance of the world economy since the early 1970's is viewed as a coincidence, or a response to common causes, rather than as a consequence of the breakdown of Bretton Woods. My purpose in selecting the title to this session was to induce critical scrutiny of these conventional attitudes. My own contribution to this task will start by describing what I conceive to have been the three essential rules of the Bretton Woods system. I shall proceed to examine the logic of those three rules in terms of recent contributions to the literature, in particular the emergent literature on policy coordination, and of recent historical experience.

I distinguish between unilateral and bilateral trading relations in an earlier article in this Review (1983) in which I examined the use of hostages (or their commercial equivalents) to support exchange. The purposes of this note are 1) to confirm the optimality of reciprocal trading by explicitly displaying the combined net benefit relations, and 2) to acknowledge a previously unremarked complication that arises when nonsalvageable assets are used as hostages in a unilateral trade.