Working Paper: CEPR ID: DP226
Authors: Guido Tabellini
Abstract: This paper investigates the desirability of international fiscal policy coordination in the presence of a domestic political distortion. The domestic distortion results from the inability of the current policy-maker to enter into a binding agreement with future policy-makers about the composition of public spending. This distortion generates a bias towards budget deficits. International coordination can exacerbate this bias, and thus reduce social welfare at home and abroad. The reason is that international coordination enables the domestic and foreign governments to form a coalition that excludes future policy-makers. This international coalition reduces the cost of running a budget deficit, and thus enhances the adverse effects of the domestic political distortion.
Keywords: international fiscal policy coordination; budget deficit; political economy
JEL Codes: 023; 025; 320; 400; 423
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Domestic political institutions (P16) | Bias towards budget deficits (E62) |
| Domestic government running a fiscal deficit (H69) | Suboptimal time path for the real exchange rate (F31) |
| International policy coordination (F42) | Mitigation of adverse effects on deficit bias (D91) |
| International coordination (F53) | Larger deficit bias (H62) |
| International coordination (F53) | Reduction in social welfare (D69) |
| Domestic political distortions (H31) | Fiscal policy choices (E62) |
| Interaction between domestic and international fiscal policies (F42) | Welfare implications (D69) |