The Need for International Policy Coordination: What's Old, What's New, What's Yet to Come?

Abstract

Fifty years ago, the Chicago School argued that flexible exchange rates would insulate employment from foreign economic disturbances: there is no need for policy coordination; flexible exchange rates suffice. Twenty five years later, the Bretton Woods system was gone, and the first generation of policy coordination models was introduced. Chicago School arguments not withstanding, these Old-Keynesian models provided a theoretical rational for policy coordination. Now, a new generation of policy coordination models is emerging. These New-Keynesian models incorporate optimizing households, monopolistic competition and nominal inertia. Here, we examine macroeconomic interdependence and the scope for policy coordination in a tractable second generation model that has received much recent attention. We relate our discussion to the old Chicago School arguments, to earlier analyses of first generation models, to recent empirical work on productivity, and to recent theoretical work on closed economy models. We conclude that second generation models may have more scope for policy coordination than did the first, and we identify the empirical work that is needed to give a serious answer to the question.