Currency Wars or Efficient Spillovers? A General Theory of International Policy Cooperation

Résumé

In an interconnected world, national economic policies regularly lead to large international spillover effects, which frequently trigger calls for global cooperation. This paper presents a unified framework of spillovers and international policy cooperation. We show that there are three and only three categories of problems that lead to inefficient spillovers and create scope for cooperation: (i) market power, (ii) imperfect external policy instruments, and (iii) imperfections in international markets. We develop guidelines for how policy cooperation can address each of the three. Then we apply our framework to a wide range of domestic and external macroeconomic policies that generate spillovers, including exchange rate management, monetary policy, fiscal policy and macroprudential policy, and discuss which inefficiencies are of concern for each. We also prove that there is no further scope for cooperation once the three sources of inefficiency have been addressed - any remaining spillovers are Pareto efficient.