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In Discussion Paper No. 1141, Research Fellows Torsten Persson and Guido Tabellini take stock of the literature on both fiscal and monetary policy in the last decade, and suggest how it may proceed in the future. They illustrate some of the most important insights of the literature, using a few core two-country models, which they extend in various directions. The paper begins with fiscal policy, using simple general equilibrium models, and considering two types of externalities: one related to international redistribution via the intertemporal terms of trade, and the other, a fiscal externality in capital taxation, when capital is internationally mobile. In the second part of the paper, the authors discuss monetary policy, using a 'generic' two-country macroeconomic model, which focuses on the externalities that arise from static terms of trade effects. Two main themes emerge from the analysis. First, the analysis of international policy interactions is enriched by taking into account the incentives in the domestic policy process. These can either be tied to credibility issues or to political institutions. Generally, a two-way interaction is identified: the incentives in the domestic policy process spill over into the international arena, and international strategic considerations partly influence domestic policy-making. The second theme is a focus on the role of institutions that can enforce and support international cooperation. The authors discuss alternative task assignments between member countries and the central policy-making level, and alternative processes for collective decision-making. The design of international institutions shapes the policy outcomes and the distribution of the gains from coordination, particularly if countries are asymmetric. Double-Edged Incentives: Institutions and Policy Coordination Torsten Persson and Guido Tabellini Discussion Paper No. 1141, February 1995 (IM) |