Paul Levine

Fiscal policy coordination and EMU: A dynamic game approach

This paper considers fiscal policy coordination in a European Economic and Monetary Union (EMU). We use an overlapping generations model which leads to departures from Barro-Ricardian neutrality. In our calibrated model, however, we find these departures to be rather small. Two models are considered: EMU with one good; and a two-good EMU. We find that in the two-good EMU model, as relative prices can change, countries have an incentive to improve their terms of trade. This externality together with increased real interest rates - shared by all EMU countries - leads to an inefficient outcome in the non-cooperative case. Thus fiscal policy coordination can lead to significant welfare gains. With government spending externalities, however, the negative externalities can offset positive ones arising from government spending, such as defence. Furthermore, in the one-good EMU model, cooperation can be counterproductive. We conclude that the case for fiscal policy coordination depends upon the nature of both the economic integration in Europe and the externalities from government spending.

Can reputation resolve the monetary policy credibility problem

Abstract This paper addresses three problems with ‘reputational’ equilibria in the Barro-Gordon monetary policy game: the multiplicity of equilibria, the coordination problem and a ‘chisel-prone’ credibility problem. A ‘chisel-proof’ credibility condition ensures that in response to a small deviation from the low inflation rate by the central bank, it never pays for the private sector to acquiesce. If the private sector can coordinate, then a low but nonzero inflation outcome can be supported as a subgameperfect and ‘chisel-proof’ credible noncooperative equilibrium. For an atomistic private sector the result can still hold in a game between successive monetary administrations.

A model of the international arms market

Sales of arms are a significant component of international trade and raise a range of pressing policy issues. After a short review of the market, this paper provides a formal model of the trade which allows for competing forward‐looking suppliers whose welfare depends on both the economic benefits from the sales and the security repercussions of recipient behaviour. The recipients behaviour depends on its military capability, a function of the stock of arms it has acquired. We first examine a myopic recipient, whose behaviour depends on current stocks, then a forward looking recipient for whom questions of the time‐consistency and the credibility of supplier threats to embargo or promises to resupply become crucial. Finally we examine the impact of supplier cooperation of the sort currently being discussed in the UN Security Council.

Should rules be simple

The principal argument of the paper is that in an incomplete information setting, where the private sector lacks information of government objectives and has to learn about the policy rule by direct observation and estimation, simple ‘sub-optimal’ rules may outperform the more complicated rule which is optimal under complete information. This result is demonstrated by simulations using an overlapping contract rational expectations model. The paper thus provides some formal reasoning to support arguments for simplicity associated with credibility and the need for the private sector to be able to monitor policy.

The design of economic policy under model uncertainty

This paper examines how considerations of model uncertainty can affect policy design. Without such considerations one may expect that choice of policy control rules for a macroeconomic model would depend on some welfare criterion based on the model as given. However if there is uncertainty in the structure of the model or in the values of particular model parameters then it is argued that choice of policy should take this into account.We introduce and define some measures ofrobustness which describe how well a particular control rule performs when the model is uncertain. These can only be evaluated using Monte-Carlo simulations; in that sense they are ‘ex post’. Then we define a number of indicators which may be of use in predicting robustness, and which do not require simulations to calculate. In that sense they are ‘ex ante’.Lastly we evaluate the ‘ex ante’ indicators on a small macromodel by comparing their predictions with the actual robustness outturn for the range of possible control rules. We find that use of the indicators in choosing rules yields some improvement on the ordinary welfare criterion, especially when the shocks hitting the system are unknown.

Robust rules for G3 macroeconomic policy coordination

Abstract The paper addresses the problem of designing cooperative policy rules for the G3 countries to cope with two forms of uncertainty. Exogenous uncertainty arises from shocks to oil prices and commodity prices, and endogenous uncertainty is modelled by the residuals of the econometric model GEM used for the design exercise. Employing state-space modelling techniques we obtain a Markov process to characterize endogenous uncertainty, and then use stochastic optimization methods to evaluate the optimal policies. Simple rules for fiscal and monetary policy are found for the G3 economies, with good robustness properties with respect to both endogenous and exogenous uncertainty.

Partial information and volatility in a two-bloc world

This paper examines the effects of partial information on volatility and on the design of simple feedback rules in a rational expectations context. Previous studies have investigated these effects using small analytical models. Here we employ an empirical two-bloc model derived from the OECD Interlink model. The main conclusions are that when current asset prices are observed, but GDP is observed with a delay, then the effect on volatility is small, compared to the full information case. Likewise the choice of simple feedback rules is little affected, although a non-optimal use of information in their design may lead to a deterioration in performance.