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Can different nations play the same game by the same rules in order to coordinate economic policy? That is the question explored in a new Harvard Kennedy School Faculty Research Working paper authored by Jeffrey Frankel, James W. Harpel Professor of Capital Formation and Growth.
Frankel traces the history of international economic cooperation and examines four relatively common models for coordinated macro-economic policy: the “locomotive game,” in which cooperation denotes joint expansion; the “discipline game,” in which cooperation entails joint fiscal rectitude; currency wars; and competitive depreciation, also referred to by some as currency manipulation.
“It is too soon to say whether we will see a full-blown return of international coordination either in the outcomes of meetings of economic policy-makers or in academic research. But the subject is ‘live’ enough to merit a re-examination in the wake of such developments as the Global Financial Crisis, unconventional monetary policies, and the currency wars framing,” Frankel writes.
Frankel’s analysis reveals that coordination on an international level is extraordinarily complex when it comes to macroeconomic policy and may not always produce its intended effects.
“The existence of such a wide variety of models forces us to confront the likelihood that any given model is very likely to be wrong,” Frankel finds. “Negotiators will be able to come up with a coordinated package of policy changes that each believes will leave their own country better off, and perhaps will be able to ignore that they don’t understand why the other side wants to make the deal. Under these conditions, international coordination can take place. But it could make things worse – when it moves policy settings in the wrong direction -- as easily as better.”
Frankel finds that the possibility of international cooperation is also often undermined by disagreements among domestic interest groups, whose interests may not align.
“Consider the complaints of the tradable sector in Brazil when the real was so strong in 2010. The country’s leaders naturally found it easier to blame the capital inflow and strong real on easy monetary policy on the part of a Federal Reserve that was heedless of international spillover effects than to admit that its own fiscal policy was too loose and that the interest rate, capital inflows, currency appreciation, and trade deficit were natural concomitants. It would have been better to have a clear understanding and debate domestically about the tradeoffs than to call for international coordination.”
“These and other examples undermine the calls for international coordination,” Frankel concludes. “When two players sit down at the board, they are unlikely to have a satisfactory game if one of them thinks they are playing checkers and the other thinks they are playing chess.”
Jeffrey Frankel, James W. Harpel Professor of Capital Formation and Growth
“When two players sit down at the board, they are unlikely to have a satisfactory game if one of them thinks they are playing checkers and the other thinks they are playing chess.” --Jeffrey Frankel, James W. Harpel Professor of Capital Formation and Growth, Harvard Kennedy School