Policy Coordination
How LDCs Might Benefit

Macroeconomic policy coordination by the developed economies could have a powerful effect on the welfare of the less developed countries (LDCs), according to Warwick McKibbin and Research Fellow Jeffrey Sachs.

In CEPR Discussion Paper No. 56 they describe a simulation model which can be used to analyze the effects of OECD macroeconomic policies on global macroeconomic equilibrium. Their model focusses in particular on the effects on the LDCs of alternative mixtures of monetary and fiscal policies in the OECD. Though the model is small, it has several properties which make it attractive for policy analysis. First, the important stock-flow relationships and intertemporal budget constraints are carefully observed, so that the model is useful for both short-run and long-run analysis. Second, behaviour in asset markets is forward-looking, so that the movement of the exchange rate is for example affected by the entire future path of policies rather than by a short-run expectations mechanism. Third, the model can incorporate policy optimization exercises, and in particular be used to study the global effects of coordination versus non- coordination of macroeconomic policies in the OECD. The model distinguishes between the effects of monetary versus fiscal policies, as well as policies in the US versus the rest of the OECD and it is possible to calculate policy multipliers for fiscal and monetary impulses in the US and the rest of the OECD.

Simulations using the model suggest that the developing countries are quite strongly affected by the absence of effective policy coordination among the developed economies. McKibbin and Sachs present an historical simulation which examines the implications had there been a coordinated policy response by the developed economies to the 1979 OPEC oil price shock. In addition they examine the impact of a shift in the US commencing in 1984, towards smaller fiscal deficits and more expansionary monetary policy.

McKibbin and Sachs argue that these simulations highlight an aspect of the benefits to coordinating policies between the US and the rest of the OECD not previously remarked upon. There are substantial gains to the less-developed countries which can emerge from policy coordination among the developed countries. The authors note that in inflationary periods, non-cooperative policies in the developed countries lead to high world interest rates. Successful policy coordination can reduce such rates to the benefit of the LDCs.


Macroeconomic Policies in the OECD and LDC External Adjustment
Jeffrey Sachs and Warwick McKibbin

Discussion Paper No. 56, March 1985 (IM)