Chapter 38 Double-edged incentives: Institutions and policy coordination

This chapter focuses on institutions and policy coordination. A large portion of international macroeconomics deals with the international transmission of national macroeconomic policies. Such spillovers naturally raise the possibility of inefficiencies: national policymakers, who set their fiscal and monetary policies to maximize a domestic objective, but ignoring the externalities that they impose on other countries, may find themselves in equilibria that entail collective irrationality. The chapter presents a detailed discussion on the fiscal policy. The illustrations revolve around two types of externalities: one tied to international redistribution via the intertemporal terms of trade and the other to a fiscal externality in capital taxation, when capital is mobile among countries. The analysis in the chapter does not rest on explicit micro foundations, but on quadratic payoff functions and linear and static macroeconomic models. Two main themes emerge from the analysis. First, that the analysis of international policy interactions is enriched by taking the incentives in the domestic policy process into account. The second central theme focuses on the institutions that can enforce cooperation. The chapter also discusses tax competition, domestic institutions in fiscal policy, and international institutions in fiscal policy.