Sustainable International Monetary Policy Cooperation

Abstract

We provide new insight on international monetary policy cooperation using a two-country model based on Benigno and Benigno (2006). Assuming symmetry, save for the volatility of (markup) shocks, we show that an incentive feasibility problem exists between the policymakers across national borders: The country faced with a relatively more volatile markup shock has an incentive to deviate from an assumed Cooperation regime to one with Noncooperation. More generally, a similar result obtains if countries differ in size. This motivates our study of a history-dependent Sustainable Cooperation regime which is endogenously sustained by a cross-country, state-contingent contract between policymakers. Under Sustainable Cooperation, the responses of inflation and the output gap in both countries are different from those induced by the Cooperation and Noncooperation regimes reflecting the endogenous welfare redistribution between countries under the state-contingent contract. Such history-contingent welfare redistributions are supported by resource transfers affected through incentive-compatible variations in the terms of trade (or net exports). Such an endogenous cooperative solution may also provide a theoretical rationale for perceived occasional cooperation between national central banks in reality.

Time Consistency and Counterproductive Monetary Policy Cooperation in a Two‐Country New Keynesian Model

“…In an open economy, Jensen (1994) analyzes a static two‐country model and finds that the set of discount factors that support policy cooperation shrinks as the country sizes become more heterogeneous. In a recent paper, Fujiwara, Kam, and Sunakawa (2019) examine the quantitative implications of sustainable cooperative monetary policies and show that the temptation to deviate from a cooperation agreement arises when countries differ in the volatilities of markup shocks. Although Jensen and Fujiwara, Kam, and Sunakawa investigate the sustainability of policy cooperation between governments that are not subject to the time consistency problem, our paper explores the sustainability of the monetary policy when the two governments set the monetary policy together and face the temptation to jointly defect from the preannounced policy.…”

Reform of the International Monetary System. Why and How?, by John B.Taylor (MIT Press, Cambridge, MA, 2019), pp. 152.

“…Taylor argues that reform should make the institutional procedures of policy‐making more conducive to a rule‐based IMS. According to Fujiwara et al (), the gains from international monetary policy coordination are large. According to Taylor, central banks do not need to coordinate, but monetary policy needs to be harmonised in a strategic and predictable way.…”