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Many recent analyses have examined the potential benefits from the international coordination of macroeconomic policies and whether such coordination is sustainable. In analyses of cooperative policies it is also important to consider the related issues of credibility and the reputation of government policy- makers vis-a{^p^h2}-vis the private sector. Credibility depends on whether an incentive exists for governments to renege on their earlier policy announcements to the private sector. If there is an incentive to renege then the policy lacks credibility and is time-inconsistent. If the fully optimal policy is time- inconsistent then the need for credibility will restrict the government to pursuing time-consistent policies, which in general produce lower welfare. In considering the sustainability of cooperative macroeconomic policies it is therefore important to consider not only whether governments have an incentive to renege on each other but also whether they have an incentive to renege on the private sector. The latter issue has only recently received attention. In a previous Discussion Paper, No. 102, Programme Director David Currie and Research Fellow Paul Levine investigated these issues in the context of a simple analytical model. In Discussion Paper No. 198, they investigate with Nic Vidalis the same questions using Minilink, an empirical two-bloc model of the USA and the rest of the OECD. The private sector in the two blocs is treated as a third, separate 'player'. The authors consider four possible policy regimes: cooperative reputational, cooperative non-reputational, non-cooperative reputational, and non- cooperative non-reputational. The performance of each of these policy regimes is investigated in the face of aggregate demand and aggregate supply disturbances occurring in either the USA or the rest of the world. Currie and his co-authors find that the benefits of international cooperation and reputation are interdependent. Without reputation, the gains from cooperation are small and quite possibly negative, and without cooperation, reputational policies perform badly. The simulations confirmed the authors' earlier, theoretical results that of the four strategies the cooperative and reputational policy yields by far the highest pay-off. The pay-offs from the other three policies were very similar but much smaller. The gains from coordination of reputational policies are found to be much greater when dealing with more long-lived disturbances. These benefits are also greater in the longer run than in shorter periods, since outside the cooperative reputational regime governments discount the future more heavily, resulting in highly unsatisfactory long-run equilibria. The authors' simulations also indicate that reputational policies are sustainable with respect to the private sector. Problems of time inconsistency arise only when disturbances to the model are short-lived, in which case the gains from reneging are small in any event. Future work by Currie et al. will investigate these issues in other empirical models, to see whether their findings are robust to changes in model specification. International Cooperation and Reputation in an Empirical Two-Bloc Model David Currie, Paul Levine and Nic Vidalis Discussion Paper No. 198, July 1987 (IM) |