International Policy Coordination in a World with Model Uncertainty

Abstract

This paper considers the design and desirability of rules for the international coordination of macroeconomic policies in a world characterized by model uncertainty. It is argued that the presence of model uncertainty, far from rendering cooperation unattractive, may actually provide a compelling incentive to coordinate policies, provided policymakers recognize that they cannot know the true model. In order to quantify the benefits from coordination, confidence regions are specified for the parameters in MINIMOD; it is assumed that policymakers in the United States and the rest of the world use these ranges as their subjective probability priors. It is shown that the expected value of gains from coordination of policies may be large, despite substantial uncertainty about the parameters.