From iMFdirect by Olivier Blanchard, Jonathan D. Ostry, and Atish R. Ghosh:
International policy coordination is like the Loch Ness monster: much discussed but rarely seen. Going back over the decades, and even further in history to the period between the Great Wars, coordination efforts have been episodic.
Coordination seems to occur spontaneously in turbulent periods, when the world faces the prospect of some calamitous outcome and the key players are seeking to avoid cascading negative spillovers. In quieter times, coordination is rarer—though not unheard of; the Louvre and Plaza accords are examples.
Today, policy coordination has resurfaced as a hot topic: while the worst of the global financial crisis is behind us, no one would claim that a return to “Great Moderation” is in the cards, and policymakers around the globe appear worried about policy transmissions across many dimensions.
Views on the size of cross-border policy spillovers have evolved over time, but today no one doubts that we live in an interconnected world. In the 1980s, the literature often concluded that these cross-border effects were small, but more recent evidence suggests that spillovers are sizable, reflecting the increase in trade and financial integration. And spillovers are generally larger in turbulent times.
The externalities associated with cross-border spillovers also reflect a paucity of policy instruments relative to targets—which means that it is difficult, not to say impossible, for a country to inoculate itself against the cross-border policy transmission. If the number of instruments equals the number of targets, cooperative and non-cooperative outcomes will be the same, and there will be no gains from international coordination. The legacy of the global financial crisis—high public debt, near zero interest rates, and at times what looks like domestic political dysfunction—suggests that nowadays policymakers have fewer policy tools to achieve their manifold objectives. In such circumstances, gains from policy coordination across countries are likely to be larger than during the Great Moderation.
Coordination is seen, occasionally. The global fiscal stimulus enacted in the early days of the financial crisis is a case in point. The fiscal expansion, exerting a positive cross-border spillover (and thus an insufficient stimulus in the non-cooperative equilibrium), is generally seen to have raised global welfare. There may have been other factors at work at the time as well: the stigma of rising public debt may be less when everyone is engaging in expansion than when only some countries are doing so. Other examples of coordinated policies during the crisis include the pursuit of tax havens and the commitment to eschew protectionism and competitive depreciation to support aggregate demand.
But there may be cases where countries don’t pursue the potential gains from coordination. A case in point is unconventional monetary policies. The major currency areas (the U.S. Fed, the European Central Bank, and the Bank of Japan) did not coordinate their monetary expansions, which reflected domestic objectives. Yet spillovers from such policies are likely to have been large, through both trade and financial flows. What might account for the international community’s failure to pursue the potential gains from coordination?