bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

THE OPEN ECONOMY AND MONETARY POLICY 301
policy through membership of a fixed exchange rate regime as long as the
exchange rate parity is itself credible.
The second issue relates to the temptation felt by governments to renege
on their agreements with other governments. The issue hardly arises in the
Hamada two-country model since an attempt by one country to improve its
position by reneging on the agreement will be met by a withdrawal of the
other country from the agreement — both countries move back to the original
sub-optimal non-cooperative equilibrium and are worse off. The threat
of such action prevents either country from reneging. However, with more
than two participants, the question of the credibility of threats becomes relevant.
Where the incentive to renege on agreements cannot be removed by
credible threats to retaliate, policy coordination cannot be sustained.
There are two ways out of this dilemma. The first is to concentrate on
the notion of reputation. Governments may adopt a longer term view of
coordination than is implied by the one-off bargains that dominate the world
of policy models. Consequently, they may be willing to forgo potential
short-term gains available from reneging on agreements in order to make
future bargains possible. Yet again, the loss of reputation in the field of
macroeconomic policy coordination might be thought likely to affect a
country’s standing in other international negotiations. This is an example of
the problems involved in analysing macroeconomic policy in isolation. It is
clear that the outcomes of G7 economic summits have been influenced by
much more than narrow macroeconomic considerations.
The second way out is to develop arguments in favour of rule-based
rather than discretionary policy coordination. The acceptance of rules
means that all governments are pre-committed to agreed polices, removing
the dangers apparent in cases where some parties are effectively pre-committed
but others are not.
A considerable number of empirical studies have been undertaken.
These have produced mixed results regarding the benefits from macroeconomic
policy coordination. On balance, where studies have shown gains
from coordination, they have tended to be rather small, although the gains
appear to increase with the persistence of disturbances that lead to coordination.
They also appear to increase over time. In the long run, gains from
cooperation in the face of permanent supply or demand shocks may be very
considerable. Such studies are of some interest in themselves but the ability
of researchers to vary the results by making relatively small changes in
their models means that they can, at best, provide only luke-warm support
for policy coordination.