Policy Coordination
An idea whose time has come?

Policy coordination occupies a prominent place on the international economic agenda and is now the focus of a major CEPR research programme. At a lunchtime meeting on April 23, Michael Artis and Richard Portes discussed the background to international economic policy coordination in the postwar period and outlined the theoretical and empirical research now under way to deepen our understanding of the potential benefits of coordination.

Michael Artis is Professor of Economics at the University of Manchester and a Research Fellow in the Centre's International Macroeconomics programme. Richard Portes is the Director of CEPR and Professor of Economics at Birkbeck College, London. The lunchtime meeting at which they spoke was jointly sponsored by CEPR and the Royal Institute of International Affairs. It marked the publication of a Chatham House Paper by Artis and Dr Sylvia Ostry, Deputy Minister in the Canadian Department of External Affairs, on international Economic Policy Coordination.

Michael Artis began by noting that national economies are now subject to a higher degree of interdependence than ever before, largely due to international flows of trade and capital. Economic policies pursued by one government will therefore affect not only their own, but also other countries' citizens. For this reason, the policies pursued by one government should ideally take into account these repercussions or 'spillover effects'.

There was a strong case for cooperation under these circumstances, Artis argued. Under floating exchange rates there was a temptation to reduce domestic inflation with exchange rate appreciation. Yet not all countries could implement this policy simultaneously; and if several did, the result might be a reduction in inflation at a very high cost in terms of reduced output. The pursuit of such policies might be advantageous for one country in isolation but is liable to produce outcomes inferior to those which could be achieved by cooperation. This cooperation could take a variety of forms, ranging from the tacit acceptance of rules of 'good behaviour' to more formal arrangements. Artis argued that although there was already some economic cooperation among nations, the danger of unplanned 'spillover' effects created a need for greater coordination.

Artis maintained that the institutional framework for the international economy set up at Bretton Woods in 1944 served the world well for 25 years. The success of the fixed exchange rate system had depended, however, on strong economic leadership by the United States and on relatively immobile capital. When the Bretton Woods system began to show serious strains, many economists argued that a system of flexible exchange rates might remove the constraints imposed by economic interdependence and give each country's policy-makers the freedom to pursue their own economic objectives. No policy coordination would be needed - exchange rate adjustments would suffice. Instead, according to Artis, the experience of floating rates had been disappointing and had led to a renewed desire for closer management of exchange rates and the more conscious coordination of economic policies. Policy coordination was once more high on policy-makers' agendas, but the United States had only very recently been converted to this view, and its implications had yet to be fully appreciated.

Artis did not underestimate the problems involved in the quest for more coordinated policies. Nonetheless, a new receptiveness on the part of the United States towards increased cooperation and an expanded role for institutions such as the IMF could supply an element of 'leadership', which was perhaps the key ingredient for successful policy coordination.

Turning to the prospects for the Tokyo summit, Artis warned that the experience of recent economic summits did not suggest that much progress would be made on the detailed business of policy coordination. The discipline of discussing economic issues in an international framework was beneficial, as was the opportunity to raise issues of concern. But the role of summits was limited: they could help to establish guidelines for cooperation and could catalyse institutional reforms. But progress towards international policy coordination would have to be taken within the framework of the established institutions of the international economy, such as the World Bank, the IMF and the GATT.

Portes began his talk by noting that UK economists have pioneered academic research on international economic policy coordination, and that CEPR has played a leading role in making macro policy coordination a respectable topic. In June 1984, the Centre held a major conference on International Economic Policy Coordination jointly with the National Bureau of Economic Research (described in CEPR Bulletin No. 4). CEPR then launched an Anglo-French programme of research on macroeconomic policy coordination in Europe; now the Centre and the Brookings Institution have begun a large-scale research effort on macroeconomic interactions and policy design in the world economy (described in Bulletin No. 13).

It was unfortunate, Portes argued, that the 1978 Bonn summit established an image of policy coordination as coordinated reflation. This image has since been exploited by those who believe that each country should 'put its own house in order' with 'hands-off' policies, but it is quite unjustified. Indeed, for some time many proponents of policy coordination have supported a package which involves different macro policy thrusts for different countries - US fiscal contraction, combined with demand expansion in Japan, Germany and the United Kingdom, associated with supply-friendly measures in the latter two.

Discussions leading up to the Tokyo Summit had put less emphasis than previously on exchange rate 'target zones' and exchange rate management as the centrepiece of macro policy coordination. Research in Britain had anticipated the emerging broader approach. CEPR researchers such as James Meade, David Vines, David Currie and Mike Artis have pioneered the exploration of nominal income targeting and its relation to the use of the exchange rate, interest rate and inflation rate as intermediate targets or indicators for policy. The proposed 'medium-term framework for the world economy' takes this broader view, focussing on nominal and real growth rates and the current account, with the IMF taking on a key role in assessing the consistency of national policy objectives. Even if countries proved unwilling to adjust their policies if they were judged inconsistent, EMS experience as well as research by Andrew Hughes Hallett suggests that there are considerable benefits in the process of moving from isolated national policy-making to coordinated policy discussions, even if this does not yield cooperative policies.

The North-South dimension of macroeconomic interaction has been badly neglected, Portes continued. All we have, he argued, are debt projection models which tell us how fast the OECD must grow to keep the debtors afloat. There were only a few pioneering analyses, like those of Sweder van Wijnbergen in the first issue of Economic Policy and Jeff Sachs and Warwick McKibbin in CEPR Discussion Paper No. 56 (reported in Bulletin No. 9/10), which address the relations between macro policy in the industrial countries and the Southern concerns with commodity prices, interest rates, and debt servicing capacity. Even if the summiteers in Tokyo did discuss the Baker Plan, their staffs have neither the analytical nor the empirical tools to tell them how macro policy coordination among the Seven might affect Third World economic performance and debt servicing capacity and how that in turn feeds back on OECD trade, interest rates and growth.

Portes noted that at the conference CEPR organized almost two years ago, Richard Cooper had identified one of the obstacles to policy coordination as disagreement on the relationship between policy instruments and objectives, the 'technology' of economic policy. Stephen Marris had gone so far as to argue that research on policy design is useless as long as the empirical models disagree about the magnitudes and even the directions of spillover effects from one country to others.

Portes contended that today this objection seemed much weaker. One of the first events in the Brookings-CEPR research programme was a conference held by Brookings in March, which considered simulations of various policy packages using the major existing models of the world economy. Portes described some of the results of simulations involving fiscal contraction in the United States and expansion elsewhere. The models were by no means unanimous, but Portes claimed there was enough agreement in the simulation results to suggest that these models are sufficiently robust to serve as the basis for discussions of policy coordination. Policy-makers must realize that we do know enough about the world economy to coordinate policies, Portes concluded.