Working Paper: NBER ID: w23004
Authors: Anton Korinek
Abstract: In an interconnected world, national economic policies regularly lead to large international spillover effects, which frequently trigger calls for international policy cooperation. However, the premise of successful cooperation is that there is a Pareto inefficiency, i.e. if there is scope to make some nations better off without hurting others. This paper presents a first welfare theorem for open economies that defines an efficient benchmark and spells out the conditions that need to be violated to generate inefficiency and scope for cooperation. These are: (i) policymakers act competitively in the international market, (ii) policymakers have sufficient external policy instruments and (iii) international markets are free of imperfections. Our theorem holds even if each economy suffers from a wide range of domestic market imperfections and targeting problems. We provide examples of current account intervention, monetary policy, fiscal policy, macroprudential policy/capital controls, and exchange rate management and show that the resulting spillovers are consistent with Pareto efficiency, but only if the three conditions are satisfied. Furthermore, we develop general guidelines for how policy cooperation can improve welfare when the conditions are violated.
Keywords: International Policy Cooperation; Economic Spillovers; Pareto Efficiency
JEL Codes: D61; F13; F33; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| policymakers act competitively in the international market, have sufficient external policy instruments, and if international markets are free from imperfections (F68) | allocations and spillovers can be Pareto efficient (D61) |
| deviations from these conditions (C62) | opportunities for cooperation (F55) |
| presence of market imperfections (D43) | need for coordinated policy efforts (F42) |