International Policy Coordination: The Loch Ness Monster

IMF Blog, December 15, 2013

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Coordination is "much discussed but rarely seen."
Coordination efforts have been episodic across decades, including the period between the Great Wars.
Coordination tends to occur "spontaneously in turbulent periods" when key players seek to avoid cascading negative spillovers.
In quieter times coordination is rarer, though historical examples include the Louvre and Plaza accords.

Views on the size of cross-border policy spillovers have evolved: literature in the 1980s often concluded effects were small, while "more recent evidence suggests that spillovers are sizable, reflecting the increase in trade and financial integration."
"Spillovers are generally larger in turbulent times."
Externalities reflect a paucity of policy instruments relative to targets, making it difficult or impossible for a country to inoculate itself against 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.
Legacy of the global financial crisis—"high public debt, near zero interest rates, and at times what looks like domestic political dysfunction"—suggests policymakers have fewer policy tools; in such circumstances gains from policy coordination across countries are likely to be larger than during the Great Moderation.

Coordinated actions cited as beneficial:
- The global fiscal stimulus enacted in the early days of the financial crisis is "generally seen to have raised global welfare."
- Coordinated pursuit of tax havens (noted as an example) and the commitment to eschew protectionism and competitive depreciation to support aggregate demand.
Non-coordination example:
- Major currency areas (U.S. Fed, European Central Bank, Bank of Japan) "did not coordinate their monetary expansions," despite likely large spillovers through trade and financial flows.

Uncertainty and disagreement on the size and sign of cross-border effects make negotiation and sustaining coordinated outcomes harder.
- Example: a monetary expansion can raise demand for exports in the rest of the world (positive spillover) but appreciate other currencies (negative spillover).
- Source and recipient countries may differ on the size or sign of the net spillover.
Unconventional policy instruments increase uncertainty: "the policy instruments are unconventional and their effects less certain."
Other impediments discussed by Ostry and Ghosh include:
- A lack of focus on domestic policy tradeoffs (necessary condition for successful coordination).
- Inherent asymmetries in the global economy.

There must be "large and clear gaps between cooperating and not cooperating" to overcome the tendency of countries to act unilaterally.
It must be clear how each player can contribute to the global outcome.
Coordination is easier when "all players have to do the same thing" (for example, expand fiscal policy or refrain from competitive depreciations).
When quid pro quo arrangements are complex, coordination is more difficult and may not occur even if theoretical gains are large.

Role for a "neutral assessor" to clarify the nature of spillover effects and make cooperative outcomes easier to establish and sustain.
The IMF already plays a role as an assessor through country surveillance and, by recognizing increased interconnectedness, "it is playing a greater role in identifying spillovers."
The IMF can help identify policies "that would be in both the national and global interest."

In some instances mutual gains from coordination may not exist—e.g., when a large country’s policies exert adverse spillovers across many smaller countries but smaller countries' actions do not affect the large country materially.
Guideposts or rules of the road (analogous to Bretton Woods rules against competitive depreciation) could help limit adverse spillovers.
- Such guideposts could take the form of warnings or stronger measures when:
- "current accounts deviate too much from current account norms," or
- "some aspects of a country’s capital account become too unbalanced, contributing to credit or asset price boom-bust cycles abroad."

International macro policy coordination will likely continue to be "heard about more often than it is seen."
Important obstacles exist to reaping coordination gains; to overcome them:
- Identify circumstances when gains are likely to be large.
- Push for specific coordinated outcomes in those cases.
- When gains are not present, acknowledge that reality.
- When large players cause significant adverse spillovers across many smaller countries, acknowledge this and consider feasible remedies.

International Policy Coordination: The Loch Ness Monster — Olivier Blanchard, Jonathan D. Ostry, Atish Rex Ghosh, December 15, 2013

Staff Discussion Note
- Staff Discussion Note (Markdown version)
- Staff Discussion Note (PDF)