Grappling with global imbalances: when does international cooperation pay?

Abstract

This article assesses the circumstances under which countries agree to engage in policy cooperation. Assuming that each country aims to maximize its own welfare, we argue that cooperation needs to be necessary, feasible, and to produce a clearly superior outcome than unilateral action. Not every situation requires policy coordination. There are cases where unilateral and conventional policy measures achieve the necessary readjustment in a welfare-optimizing way. When rebalancing does not automatically happen and the resulting situation is a source of macroeconomic instability, and of welfare losses in the aggregate, internationally coordinated policy action could lead to solutions that generate a better outcome in terms of relative welfare. These solutions, however, are not necessarily stable and players should pre-commit to binding arrangements with sanctions for defection to ensure stability. We conclude that these pre-arrangements can only work if countries trust each other or they trust a supranational body that monitors the implementation of the arrangements and sanctions defection. Copyright 2013, Oxford University Press.