International Co-ordination of Macroeconomic Policies: A Review

Abstract

n the last 30 years, there has been a significant increase in the interdependence of the industrial market economies. World trade has grown at unprecedented rates and, especially since the early 1970s, world financial markets have become more and more integrated. This experience has altered the environment within which macroeconomic policy is made. Governments and central banks are now more than ever aware of the international repercussions of domestic policy, as well as the effects on the domestic economy of outside policies. Despite this growth in economic interdependence, macroeconomic policy is for the most part still determined by sovereign governments to satisfy national objectives. This fact raises the question of whether what is good policy for a single economy is also good for its trading partners. Do individual governments, acting independently at the national level, choose policies with undesirable features at the global level? Would governments do better by co-ordinating their macro policies? There has been considerable interest in these questions in recent years, by both theoretical and policy-oriented economists, with numerous calls for increased internanational co-ordination of macroeconomic policy, generating a developing literature on the welfare effects of policy co-ordination. A large part of this interest probably stems from the experience of the early 1980s, when the US combination of tight money and expansionary fiscal policy was perceived to be exceptionally damaging to the prospects for recovery in the European economies. However, there are many other examples of situations where it was widely believed that the macroeconomic policies of the world's large economies were seriously 'out of sinc'.1 This paper reviews the issues involved in international macroeconomic policy coordination. While co-operation between governments takes place at many levels, such as in the International Monetary Fund (IMF), General Agreement on Tariffs and Trade (GATT) and the European Community (EC) etc., there has been much less experience with direct international agreements on discretionary monetary and fiscal policies. Yet the theoretical literature, utilizing the techniques of game theory, has mainly examined the benefits of this type of macroeconomic policy co-ordination. Thus, as in many areas in economics, there is some difficulty in directly applying theoretical prescriptions to actual policy