Working Paper: NBER ID: w1506
Authors: John B. Taylor
Abstract: The paper examines international issues that arise in the design and evaluation of macroeconomic policy rules. It begins with a theoretical investigation of the effects of fiscal and monetary policy in a two-country rational expectations model with staggered wage and price setting and with perfect capital mobility. The results indicate that with the appropriate choice of policies and with flexible exchange rates, demand shocks need not give rise to international externalities or coordination issues. Price shocks, however, do create an externality, and this is the focus of the empirical part of the paper. Using a simple 7 country model -- consisting of Canada, France, Germany, Italy,Japan, the United Kingdom, and the United States -- optimal cooperative and non-cooperative (Nash) policy rules to minimize the variance of output and inflation in each country are calculated. The cooperative policies are computed using standard dynamic stochastic programming techniques and the non-cooperative policies are computed using an algorithm developed by Finn Kydland. The central result is that the cooperative policy rules for these countries are more accommodative to inflation than the non-cooperative policy rules.
Keywords: macroeconomic policy; international coordination; policy rules; inflation; output variance
JEL Codes: E61; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| appropriate fiscal and monetary policies (E63) | mitigate the effects of aggregate demand shocks on real output and inflation (E00) |
| supply shocks (E39) | create externalities affecting macroeconomic performance across countries (F41) |
| supply shocks (E39) | necessitate coordinated policy responses (F42) |
| cooperative policy rules (C71) | lead to more accommodative inflation policies (E31) |
| variations in policy accommodation parameters (E60) | affect the severity of recessions following inflation shocks (E31) |