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Global Policy Coordination for Development:

The UN Global Policy Model

Servaas Storm

Delft University of Technology

February 2016 (final)

Abstract Substantive international (policy) spillover and spillback effects through trade and financial markets warrant policy preparedness and international collaboration. Paradoxically, however, the economics mainstream treats global policy coordination as a second-order issue and of limited and only temporary importance. This conclusion is based on unrealistic models which neglect the balance-sheet (stock) dimension of global integration, wholly disregard income distribution and fundamental uncertainty as determinants of aggregate demand, assume a vertical Phillips-curve and omnipotent central banks, and consequently define away any productive role for fiscal policy (coordination). The case for international policy coordination, also in quiet times and with a focus on creating space for economic development, is strong under more realistic assumptions, however. Given that (secondary) uncertainty and disagreements constitute genuine obstacles to coordination, there is a useful role to play for a “Global Policy Model” in presenting analyses of alternative scenarios and the resulting trade-offs and in building a shared understanding as the basis for cooperation. The U.N. Global Policy Model could be developed to take up this role. Acknowledgment: I am grateful to Alex Izurieta, Jeronim Capaldo, Francis Cripps and Jo Michell for the very valuable feedback they provided on policy modelling in general and on the U.N. Global Policy Model in particular. Pablo Bortz provided very thoughtful comments on a first draft. I thank Sebastiaan Leysen for providing me with the estimates of the global value-added spillover effects in Table 2.

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1. Introduction and problem setting

It is a truism of sorts that our world economic order has profoundly changed after the 1980s,

as countries have become more extensively and more deeply integrated, mostly on the back of

a deregulated financial globalization. As a result, the financial pandemonium following the

Great Financial Crisis of 2007-8, which originated in the world-economy’s core—the U.S.

and the OECD economies—, was globalized faster, deeper and broader to the countries in the

periphery through trade and finance than ever before (Kaminsky and Reinhart 2003; Singh

and Zammit 2010; UN-DESA 2015). In response, the globalized crisis prompted an

unprecedented degree of “emergency Keynesianism” worldwide and importantly most of

these fiscal stimulus measures were coordinated and jointly implemented. “By acting together

…. we will bring the world economy out of recession …”, stated the G-20 (2009) at the height

of the crisis, “we are undertaking an unprecedented and concerted fiscal expansion, which

will save or create millions of jobs which would otherwise have been destroyed ….” There is

broad consensus that these coordinated Keynesian policies helped to avert another great

depression and to stabilize the global economic and financial system (Benes et al. 2013; Ostry

and Ghosh 2015)—a consensus which has led to a renewed interest in “revisiting the benefits

of international policy coordination”—as stated by IMF economists Benes, Kumhof, Laxton,

Muir and Mursula (2013). More generally, the post-1980 transformation of the world

economic order, write Adam, Subacchi and Vines (2012, p. 396), “has led to the recognition

that we are no longer in a ‘non-system’ that does not need policy cooperation, but, at the same

time, the necessary policy cooperation needs to be different from that designed at Bretton

Woods in the late 1940s.”

The renewed interest in global macroeconomic policy coordination reminds me of an

old joke in which an economist asks: “Okay, it works in practice, but does it work in theory?”

The reason is that the recognition of a clear “need for macroeconomic policy cooperation”

(Adam et al. 2012; Ostry and Ghosh 2015) is squarely at odds with what has become almost a

‘folk theorem’ in mainstream economics, namely that the welfare benefits from international

policy coordination are basically negligible, especially in ‘quiet times’. This ‘folk theorem’

goes back at least to Milton Friedman’s claim that domestic employment is insulated from

foreign economic disturbances including any spillover effects due to foreign macroeconomic

policy under a flexible exchange rate regime and sufficient cross-border capital mobility—

which is a conclusion largely upheld by New Keynesian (Oudiz and Sachs 1984; McKibbin

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1997; Taylor 2013) and New Classical economists (Canzoneri et al. 2005) alike. In the non-

coordinated post-Bretton Woods ‘non-system’ of floating exchange rates and a high degree of

capital mobility, domestic policy instruments were used to attain domestic policy goals (the

internal balance, see Temin and Vines 2013), while not much importance needed to be

attached to maintaining the external balance, as it was thought that countries would be able to

borrow internationally for considerable periods of time, and floating exchange rates would

adjust so as to enable a country to repay what it borrows (Adams et al. 2012). It is therefore

not very surprising that mainstream economics is having a rather difficult time justifying and

rationalizing the benefits of macroeconomic policy cooperation, basically because its

foundational assumptions define away the problem. Hence, mainstream economics, as I will

argue, is not going to be particularly helpful in exploring what needs to be done to

productively manage the spillover impacts of domestic macro policies on other countries in a

manner that is most conducive to the economic development of especially the countries in the

periphery, the so-called ‘emerging and developing economies’ (EDEs). What is needed are

alternative, more realistic, approaches (and models) to the challenge of designing ways to

coordinate global policy so as to ensure a return towards a satisfactory and stable global rate

of growth that is fast enough to allow for fiscal consolidation in big parts of the world, debt

deleveraging and a redressal of (current account) imbalances, while creating enough

developmental space for the EDEs.

This paper is organized as follows. Section 2 assesses the recent deepening of global

trade and financial integration and the build-up of global imbalances so as to argue that

international (policy) spillover and spillback effects through trade and financial markets are

large enough to warrant policy preparedness and international collaboration. Section 3

considers the New Consensus Macroeconomics (NCM) approach to international policy

coordination which (wrongly so, in my opinion) concludes that the uncoordinated (Cournot-

Nash) equilibrium is about as good as the—more cumbersome and fragile—coordinated one.

Section 4 identifies the need for alternative, more realistic and relevant approaches to the

challenge of international macroeconomic policy coordination, highlighting obstacles but also

considering ways how this cooperation might be brought about in support of the

developmental aspirations of the EDEs. Section 5 concludes.

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2. International interdependence, spillovers and coordination

“International policy coordination”, write IMF-economists Blanchard, Ostry and Ghosh

(2013), “is like the Loch Ness monster: much discussed but rarely seen.” Policy coordination

efforts have been “episodic” in the past, they claim, and occur mostly in turbulent—i.e.

crisis—times, when key players in the global economy seek to avoid cascading negative

spillovers effects on the performance and welfare in other countries—through international

trade, capital flows and (floating) exchange rate movements. This view, however widespread

and influential it may be, is deliberately myopic and unashamedly a-historical, as it brushes

aside, in one rhetoric sweep, the Bretton Woods policy regime (1945-1971), of which, as

argued by Adam, Subbacchi and Vines (2012, p. 397), macroeconomic policy cooperation

was “a necessary and defining feature”. The Bretton Woods system was a highly coordinated

system based on “fixed-but-adjustable” exchange rates and capital account controls, in which

one country, the U.S., established the rules of the game and the rest of the world followed suit

(Marglin and Schor 1990; Cornwall and Cornwall 2001). It lacked mechanisms for automatic

exchange rate adjustment and required IMF-supervision in the adjustment of exchange-rate

pegs (to prevent attempts at beggar-thy-neighbour policies). The Bretton Woods system

helped to stabilize exchange rates, reducing international transaction costs and significantly

raising (bilateral) trade (Rose 2000). “Analysts rarely acknowledge,” writes Helleiner (2015,

p.1) that “the Bretton Woods architects generated a number of highly original ideas about how

international policy coordination could support the development aspirations of poorer

countries.” These innovative ideas focused on the provision of long-term development

finance, short-term balance-of-payments support, capital controls, and commodity price

stabilization in ways supportive to the state-led development strategies of the EDEs. The

Bretton Woods system was replaced by a ‘non-system’, write Adam et al. (2012), featuring

floating exchange rates, free cross-border movement of capital, and the abandonment of

interventionist Keynesian policies in favour of Monetarist inflation targeting by central banks.

This transformation was completed by a deregulation of domestic financial systems and by

the introduction of non-discretionary fiscal policy rules. This ‘non-system’ did not need

global policy coordination, it was thought, for reasons given above. And it is to this ‘non-

system’ that Blanchard, Ostry and Ghosh (2013) refer. It appeared, in the eyes of most

mainstream observers to be doing well, right up until the Great Financial Crisis, and the Great

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Complacency is well summarized by Blanchard’s (2008) conclusion, penned down just before

the global financial crash, that “the state of macro [economics] is good.”

The mainstream consensus holds that in normal times, such as during the Great

Moderation, cross-border policy spill-over effects are not substantial enough, in practice, to

justify going to extra effort of trying to coordinate policies across countries. In theory, the

case for coordination goes as follows. If in the presence of significantly large policy

externalities, authorities in one country set policies to maximize domestic welfare, while

taking as given the policies in other countries (thus ignoring the spill-over effects), the

resulting equilibrium will not be Pareto-efficient (Hamada 1976). Countries can then improve

upon the non-cooperative outcome by agreeing to a joint policy package that is mutually

beneficial—basically because, in neoclassical idiom, it internalizes the “policy externality”

(Ostry and Ghosh 2015). But empirically the spillover effects for ‘quiet’ times are found to

average around one per cent (or less) of GDP per annum (Oudiz and Sachs 1984; Taylor

1985, 1993, 2013), which is considered too small to justify (monetary) policy coordination.

The un-coordinated (Nash) equilibrium is, in other words, about as good as if countries

coordinated their policies in a cooperative fashion. The G7 central bank Governors and

Finance Ministers (2013) recently appeared to endorse this view in a joint statement that

“monetary policies have been and will remain oriented towards meeting our respective

domestic objectives using domestic instruments.” And John B. Taylor (2013, p. 4)

encapsulates the consensus as follows: “By choosing policies that worked well domestically

with relatively little concern about spillover effects, central banks contributed—in “invisible

hand” like fashion—to better global economic conditions.”

But during the past fifteen years, the no-need-for-coordination consensus has been

losing ground, as new evidence began to accumulate that cross-border spillovers are sizeable,

reflecting the increase in trade and financial integration (see Almansour et al. 2015 and Ostry

and Ghosh 2015 for references). This prompted the International Monetary Fund (IMF) to

start a new annual-report series on the interconnections between the world’s economies and

on how policies in the larger economies impact the rest of the world—the IMF Spillover

Report, first published in 2011. In Table 1 appear recent estimates of growth spillovers and

spillbacks from the advanced economies to the emerging market economies (using quarterly

data for the period 1996-2013), taken from IMF (2014). Without going into the exact details

of the estimation method, these results suggest significant spillover effects from advanced to

emerging market economies (of about 50 per cent of the growth increase in the advanced

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countries), but also non-negligible spillover impacts from the emerging market economies to

the advanced countries. Not unimportantly, significant proportions of the initial impacts of

higher growth in the advanced core to the emerging market economies spill back into higher

growth in the advanced core countries—on average, this spillback impact is one-third of the

initial growth spillover effect. This suggests strong cross-border interdependence (IMF 2014).

One palpable reason is that global trade integration has deepened, with more and more

products being manufactured in vertically-oriented industrial production chains spanning

multiple countries, with each country specializing in a particular stage of the chain (Johnson

and Noguera 2012; Koopman et al. 2014; Timmer et al. 2014).

Table 1

Estimates of growth spillover and spillback effects (1996-2013)

Spillovers from a 1 percentage point increase in growth in: U.S.A. Euro Area Japan U.K. Average on growth in the emerging market countries

0.583

0.592

0.254

0.563

0.528

and subsequent spillback effect on growth in:

0.124

(21.3%)

0.298

(50.4%)

0.127

(50.1%)

0.072

(12.8%)

0.174

(34.4%) Spillovers from a 1 percentage point increase in growth in the emerging market countries on growth in:

U.S.A. 0.10 Euro Area 0.30

Japan 0.50 U.K. 0.20

average 0.20 Note: Figures in parentheses give the ratio (in percentages) of the spillback effect to the initial growth spillover effect. A full list of the emerging market economies included in the sample is given in Table 5 of Chapter 4 of the April 2014 World Economic Outlook (IMF 2014a). The sample includes Argentina, Brazil, China, India, Indonesia, Malaysia, Russia, South Africa, Thailand, and Turkey. Source: IMF (2014b), Box 4 (p. 26); and Figures 5 and 6 (p. 60).

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IMF (2014, p. 61) estimations for 2011 show that the advanced economies supply 65%

of emerging and developing countries’ imports, while the advanced economies are now

sourcing 40% of their imports from the EDEs—up from less than 20% in 1995. As a result,

the global economy features significant value added spillovers through backward production

linkages, as is shown using 2011 data from the World Input-Output Database in Table 2. To

exemplify, an increase in value added of $100 in Germany leads to the generation of an

additional $ 22.5 in foreign value added and mostly so in the EU ($10.02), the rest of the

world ($4.53), China ($2.03) and the U.S. ($1.91). On average, the cross-border value added

spillover impact due to the generation of $100 of domestic income takes a value of about $20.

Closer inspection of the rows and columns reveals that especially China and Germany are

well placed in global value chains, and that the global economy features major asymmetries in

trade, as between the U.S. and Canada, the U.S. and Mexico, and China and Australia, in

which in each case the former is benefiting more from growth in the latter country than vice

versa.

It is these asymmetries in cross-border production chains which have led to widening

trade and current account imbalances in the global economy (Cripps, Izurieta and Singh 2012;

Capaldo and Izurieta 2013; Lane and Milesi-Ferreti 2014; Storm and Naastepad 2015b), as is

illustrated in Figure 1 and Table 3. Again, I need not elaborate the details as the

problématique is familiar and its ramifications are widely debated: a few major economies

including most prominently the U.S. (but also Canada, Italy and the U.K.), were running large

and growing current account deficits, which were balanced by sharply higher current account

surpluses in net-exporting countries such as China, Germany, Switzerland, Saudi Arabia and

the Netherlands. Whatever one’s views on these imbalances, there is agreement that they are

both risky and unsustainable—if only because the deficit countries are vulnerable to

disruptive external financial market conditions including, in the extreme case, the sudden

reversal of external funding (Akyüz 2015; Bortz 2016). These observations have prompted

calls for (some degree of) international coordination of economic policies by the systemically

important countries to facilitate an orderly redressal of global imbalances (Eichengreen 2008;

Singh and Zammit 2010). Such coordination may well pay off, as simulations with the UN

Global Policy Model (2009) show: a concerted development-oriented rebalancing, centered

around fiscal stimulus in the surplus countries and featuring a resource transfer of about $50

billion to the LDCs, would not just bring about a benign unwinding of global imbalances, but

also more rapid economic growth (see also Cripps et al. 2012). But actually implementing

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such a coordinated response remains easier said than done—as governments and central banks

continue to be reluctant to act contrary to the self-interest of their own country to achieve the

global common good (Stevens 2013).

Figure 1

Global current account imbalances 1980-2013 (per cent of world GDP)

Source: IMF (2014), Figure 4.1, p. 117.

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Table 2

Global (backward-linkage) value-added spillovers, 2011

USA Canada UK France Germany Italy Rest of EU Japan Russia China India

Rest of Asia

Austra- lia Brazil Mexico RoW

USA 100.00 8.04 2.87 1.82 1.91 1.38 2.97 1.20 0.50 1.91 1.48 4.01 1.80 1.40 8.37 1.89

Canada 1.74 100.00 0.81 0.34 0.43 0.26 0.49 0.32 0.09 0.39 0.29 0.68 0.25 0.38 0.84 0.29

UK 0.50 0.78 100.00 1.13 1.45 0.81 2.03 0.17 0.32 0.29 0.37 0.63 0.59 0.28 0.28 0.83

France 0.25 0.30 0.97 100.00 1.25 1.22 1.43 0.13 0.32 0.31 0.17 0.46 0.27 0.42 0.27 0.66

Germany 0.60 0.61 2.21 3.09 100.00 2.52 4.24 0.31 1.27 0.92 0.56 1.23 0.63 0.81 0.84 1.52

Italy 0.21 0.23 0.67 1.25 0.99 100.00 1.56 0.09 0.41 0.27 0.21 0.32 0.26 0.31 0.30 0.63

Rest of EU* 1.08 1.09 4.58 4.76 6.33 4.24 100.00 0.46 1.95 1.09 0.85 1.75 1.00 0.95 1.06 2.63

Japan 0.57 0.49 0.50 0.42 0.57 0.35 0.48 100.00 0.62 1.41 0.44 4.04 0.78 0.32 0.76 1.34

Russia 0.44 0.27 0.80 1.12 0.92 3.13 2.90 0.70 100.00 0.89 0.32 1.20 0.37 0.32 0.35 0.99

China 1.62 2.05 1.54 1.37 2.03 1.45 1.94 1.96 1.40 100.00 2.59 4.66 3.11 1.00 2.22 2.46

India 0.32 0.43 0.45 0.24 0.40 0.29 0.41 0.15 0.07 0.20 100.00 0.48 0.33 0.14 0.20 0.32

Rest of Asia** 0.45 0.40 0.46 0.43 0.56 0.57 0.64 0.92 0.62 1.46 0.37 100.00 0.64 0.36 0.75 1.06

Australia 0.17 0.34 0.33 0.19 0.25 0.18 0.24 1.34 0.11 1.12 0.39 2.31 100.00 0.15 0.19 0.41

Brazil 0.31 0.32 0.26 0.40 0.63 0.41 0.46 0.17 0.12 0.42 0.14 0.51 0.24 100.00 0.35 0.35

Mexico 1.03 0.53 0.11 0.20 0.21 0.13 0.17 0.07 0.05 0.12 0.09 0.15 0.25 0.12 100.00 0.16

Rest of world 3.94 2.60 4.39 3.94 4.53 6.40 5.89 7.23 1.91 6.69 7.02 15.30 5.20 3.27 2.78 100.00

Total foreign value added spillover:

13.21 18.48 20.96 20.70 22.46 23.35 25.86 15.23 9.77 17.48 15.28 37.74 15.72 10.22 19.55 15.54

Source: Calculated based on the World Input-Output Database (Timmer et al. 2015).

Note: The off-diagonal figures show how much value added will be created in other countries by an increase in value added of $100 in the diagonal (home) country.

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Table 3

Current account balances 1990-2015 (as a percentage of Chindia’s GDP)

pre-crisis period post-crisis period 1990-1999 2000-2008 2009-2015 G7-countries Canada ─1.45 0.60 ─0.51 France 1.41 0.38 ─0.24 Germany ─1.53 2.58 2.41 Italy 0.16 ─0.42 ─0.24 Japan 9.74 5.35 1.22 U.K. ─1.63 ─1.64 ─0.96 U.S.A. ─10.43 ─20.99 ─4.40 Euro Area ─1.07 ─1.61 1.20 BRICS Brazil ─0.98 ─0.23 ─0.74 Russia 0.51 2.05 0.66 India ─0.44 ─0.06 ─0.52 China 2.07 3.74 2.29 South-Africa 0.03 ─0.16 ─0.13 Regions: Latin America ─3.88 ─0.42 ─1.18 Middle-East ─1.57 4.79 2.16 Sub-Sahara Africa ─0.66 0.21 ─0.36

Note: To scale the (period-average) current account balances, these balances are expressed as a percentage of the combined GDP of China and India which together account for one-third of world population (2.5 billion persons). Source: Calculated from IMF (2015), World Economic Outlook Database; see: https://www.imf.org/external/pubs/ft/weo/2015/02/weodata/download.aspx

As a consequence of the rapid growth of financial linkages between (advanced and

developing) countries post-1990, spillovers through the global financial system (including

banks’ balance sheets and asset markets) arguably have become even more important than the

value-added and employment spillovers through trade and outsourcing. An explosion in the

size of cross-border capital inflows and outflows has resulted in rapidly expanding stocks of

external assets as well as liabilities, both in the advanced countries and in the EDEs. For the

advanced economies, IMF data show that the ratio of gross external assets and liabilities to

GDP more than tripled: from about 140% in 1990 to more than 420% in 2007 (Lane and

Milesi-Ferreti 2014; Milesi-Ferreti et al. 2010). The exposure of the advanced economies to

risks in the EDEs has grown from 10% in 2005 to 20% of total foreign claims in 2013, while

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their exposure to risks in EDEs’ asset markets has increased as well through equity cross-

holdings and (corporate) debt holdings (IMF 2014). Over the same period, as has been

carefully documented by Akyüz (2014), almost all EDEs have deepened their cross-border

financial linkages, expanded their external balance sheets in gross terms (as illustrated in

Figure 2), and allowed the entry of foreign investors in their domestic credit, bond, equity and

property markets.1 “For the entire period of 2000-13 gross international assets and liabilities

of EDEs grew by about 15 and 12.5 per cent per annum, respectively, and their gross balance

sheets expanded by more than fivefold. About 84 per cent of gross external assets and 78 per

cent of gross external liabilities outstanding at the end of 2013 had been accumulated after

2000,” concludes Akyüz (2014, p.6). While the aggregate picture conceals considerable

diversity among various regions and countries, almost all EDEs have become far more closely

integrated into—what is generally recognized as an unstable—global financial system.

Crucially, most of the externally-held sovereign debt of EDEs, both the bonds expressed in

local currency and foreign currency, are held by, what Akyüz calls, “fickle foreign investors”

(including foreign asset managers). As a result, the EDEs have become more vulnerable to

global financial cycles and shocks “irrespective of their balance-of-payments, external debt,

net foreign assets (NFA) and international reserves position …” (Akyüz 2014, p. 2). The

EDEs have passively adjusted to global financial conditions, often allowing asset and credit

bubbles to develop, while ignoring the build-up of vulnerabilities due to growing external

liabilities—most notably through increased private-sector borrowing abroad (Bortz 2016). In

the process, the emerging and developing countries, particularly those pursuing inflation-

targeting under liberalized capital accounts such as Brazil, Indonesia and Turkey, gave up

their exchange rate as a macro-policy instrument (e.g. managed floating), as they passively

experienced sustained currency appreciations following the boom in capital inflows. This

increased vulnerability is especially worrisome in the current global conjuncture featuring an

enormous expansion of international liquidity (Belke and Gros 2010), historically very low

interest rates and a greater appetite for risk by financial investors—as was illustrated in May

2013 when the EDEs were hit by “taper tantrum”, after the U.S. Federal Reserve made public

its intention to wind down its bond buying programme under Quantitative Easing (QE). The

1 Gross assets and liabilities are more important in understanding financial vulnerabilities than net foreign asset positions, as explained by Godley and Lavoie (2007), Obstfeld (2012), Al-Saffar et al. (2013), and Bortz (2016).

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EDEs bore the brunt of the fall-out as they experienced a marked rise in financial market

volatility, sharp decline in their asset prices and exchange rates, a sudden stop and subsequent

reversal in capital flows and a slowdown in growth (Jaramillo and Weber 2013; IMF 2014;

Akyüz 2014). The result is, as Akyüz (2014, p. 38) wryly observes, that Brazil, India and

South Africa, three of the most promising BRICSs of “yesteryear”, are now called the

“Fragile5”, along with Turkey and Indonesia. Interestingly, as an aside, the heightened

financial fragility is motivating new attempts of South-South policy cooperating and

coordination, such as the Contingent Reserve Arrangement (CRA), agreed by the BRICS

countries. But the more general point is that the massive expansion of the external balance

sheets of the EDEs has made them vulnerable to an interruption of access to international

capital markets, changes in monetary policy in the advanced economies, and sudden stops of

capital flows—especially in those cases where international reserves do not cover the current

account deficit plus short-term external debt, and/or those cases where the bulk of external

(sovereign) debt is in foreign currency (Akyüz 2014). This also implies that the international

transmission mechanisms of macroeconomic policy are now primarily found in international

financial markets.

The conclusion must be that international (policy) spillover impacts through

international trade, commodity (energy) prices, and financial markets are large, complex,

multifarious and increasing. “….. policy preparedness and international collaboration are

needed,” concludes IMF (2014, p. 80), because “at the international level, collaboration

between the [advanced economies] and [emerging market economies] would be desirable in

order to manage both spillovers and risks of “spillbacks””. This raises the question why the

mainstream consensus does not recognize the need for international policy coordination—

which is the question addressed in the next section.

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Figure 2 External assets and liabilities in the EDEs, 1995-2013

(billions of US$)

Source: Akyüz (2014), Chart 2.

3. International policy coordination: the mainstream view

The mainstream literature examining problems of fiscal, monetary and exchange rate policy

interdependence and investigating possible gains or losses of international macro policy

coordination is large—as recent stock takings by Canzoneri et al. (2005), Adam, Subacchi

and Vines (2012), Taylor (2013), Engel (2015) and Ostry and Ghosh (2015) make clear.

Instead of presenting another somnolent review of the bulky theoretical and econometric

literature on global policy coordination, I use a simple—two-country, rational expectations—

model to represent the mainstream approach and evaluate its main (policy) conclusions.

Models featuring two structurally identical countries have been the work-horse of most

mainstream macroeconomic research, ever since Hamada (1976), Oudiz and Sachs (1984) and

Taylor (1985) began to use them to theoretically explore the issue of international policy

coordination (Daniels and Vanhoose 1998). Blanchard and Milesi-Feretti (2011), Subacchi

and van den Noord (2012), Taylor (2013) and Ostry and Ghosh (2015) are a few recent

examples of analytical two-country models used to investigate global policy coordination. In

fact, the model could be read as a stylized and simplified semi-reduced form model of a much

larger (econometric) two-country model, not unlike for example the IMF global policy model

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GPM6, the OECD’s Global Model (Subacchi and van den Noord 2012) or the IMF’s dynamic

multi-regional Global Integrated Monetary and Fiscal (GIMF) model (Benes et al. 2013).

3.1 A simplified two-country model

Table 4 presents the equations of the two-country model, defines the (variables) notation and

also reports representative parameter values (which I use to illustrate the domestic and foreign

effects of macro-policy in each country below). The model is written in (log) growth rates

and, of critical importance, all variables are flow variables or “prices”. If we consider country

1, equation (1) is a textbook IS curve, defining real GDP growth as a function of the (real)

interest rate, net public spending (the fiscal policy stance), the exchange rate and foreign

demand.2 In line with this literature, income distribution does not play any role in determining

aggregate demand—all considerations of wage-led or profit-led demand regimes are

conspicuous by their absence (Storm and Naastepad 2012; Onaran and Galanis 2014).

Equation (2) is a Phillips-curve, defining inflation as a positive function of real GDP growth

and of the exchange rate. Note that an increase in ε means a depreciation of country 1’s

exchange rate (which is inflationary through imports and markup pricing). It is assumed, in

line with the New Consensus Macroeconomics (or NCM, see Arestis and Sawyer 2011;

Seccareccia 2012; Storm and Naastepad 2015), that the central bank uses a monetary policy

rule (MPR) to keep actual inflation at the long-run target rate of inflation—indicated byp .

This means that equation (2) in fact determines country 1’s real interest rate. Underlying the

inflation targeting by the central bank is, what we have elsewhere called, NAIRU logic: the

presumption that inflation can only be stabilized if (using the MPR) actual unemployment is

kept equal to the NAIRU, or actual growth kept close to trend (“equilibrium”) growth (Storm

and Naastepad 2012). Equation (3), finally, follows from the assumption of perfect capital

mobility, the absence of any risk premium as well as perfect substitutability of domestic and

foreign assets: it states that the rate of depreciation of the currency of country 1 is

2 Most mainstream models, especially the ones using quadratic policy loss functions to derive the “optimal” macro policy rule using standard dynamic stochastic programming techniques, define y as the deviation of the log of real GDP from secular trend or potential GDP (e.g., Taylor 1993, 2013; Ostry and Ghosh 2015). This, of course, presupposes the existence of a “natural” rate of growth as well as an equilibrium rate of unemployment (NAIRU) which in turn implies a vertical long-run Phillips-curve. The model analysis pertains to this supposedly “long-run” case.

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endogenously determined as a function of the difference between the interest rate, r* , of

country 2 and the interest rate, r, of country 1. If r* > r, there will be a capital outflow out of

country 1, causing a deprecation of its currency. The macroeconomic policy framework thus

includes free capital account convertibility and a floating exchange rate. The same

macroeconomic structure is assumed to hold for country 2. I finally assume here that

adjustment to equilibrium is instantaneous, as there are no in-built inertia in the form of

“staggered” wage and/or price setting, all agents have perfect foresight and the central bank

has a totally credible reputation in targeting inflation. New Keynesian models assume

rigidities in the adjustment process to an exogenous shock and assess the possible temporary

benefits of policy coordination during this adjustment process. Crucially, however, once the

consequences of the shock have passed, there is no need any more for international policy

coordination. Price stickiness or other frictions could be added to the model, but these would

only alter the short-run behaviour of the model during the adjustment period. I will leave

aside an analysis of this adjustment period, during which some modicum of international

(monetary) policy coordination may (or may not) be desirable, and instead focus on the long-

run equilibrium outcome in order to highlight the assumptions giving rise to the conclusion

that a coordinated outcome is as good as the non-coordinated (non-cooperative) outcome.

16

Table 4

Two-country macro-economic model

Country 1 Country 2

* 4321 yrgy µεµµµ ++−= (1)

εββ 21 += yp (2)

Err σϑε +−= )*( (3)

yrgy * * *4

*3

*2

*1 µεµµµ ++−= (1*)

εββ * * *2

*1 += yp (2*)

*)*( Err σϑε +−−= (3*)

Variables:

y = real GDP (log)

g = real net public spending (log)

p = target inflation rate

r = real interest rate

ε = exchange rate (log)

Eσ = a random shock with mean zero and

variance 2Eσ

Variables:

y* = real GDP (log)

g* = real net public spending (log)

*p = target inflation rate

r* = real interest rate

ε = exchange rate (log)

*Eσ = a random shock with mean zero and

variance 2*Eσ

Parameter values for simulations:

;2.0;1.0;2.0 ;2.1 4321 ==== µµµµ g = 1;

3.0;0 ;1 ;3.0 ;3.0 21 ===== pEσϑββ .

Parameter values for simulations:

;2.0;1.0;2.0 ;2.1 *4

*3

*2

*1 ==== µµµµ g* = 1;

3.0*;0 ;1 ;3.0 ;3.0 **2

*1 ===== pEσϑββ .

In this model, fiscal policy produces international spillover effects through three

channels:

• a direct aggregate demand effect through international trade linkages as those reflected

in Table 4 (via coefficient 4µ ); and

• indirect interest rate effect (through the reaction of the central bank in response to the decisions taken by the fiscal authority—via equation (2)); and

• a real exchange rate effect (which will come about once r* ≠ r).

The second and third effects clearly depend on the strategic interaction between country 1’s

fiscal and monetary authorities—but, entirely in line with the NCM, the model presupposes

that monetary policy strictly dominates fiscal policy and hence the effectiveness of fiscal

policy is circumscribed by the monetary-policy imperative of keeping actual inflation at p .

Long-run fiscal discipline based on “policy rules” (not discretion) is needed to reduce fears

17

that either inflation expectations or interest rate risk premiums will become a problem in the

future. Monetary policy is similarly rule-based: the (real) interest rate is adjusted to achieve

price stability and capable of efficiently offsetting shocks to the economy. What is left

unstated is, to use Paul Samuelson’s words, that any policy rule is “set up by discretion, is

abandoned by discretion and is interfered with by discretion” (cited by Blinder and Solow

91974), as per Costantini 2015). I must further note here that inflation targeting-cum-floating

exchange rates have become the predominant policy approach in the EDEs—frequently at the

behest of the IMF (Gabor 2010). In this set-up, there necessarily arises a trade-off between

price stability and output growth, because a currency depreciation raises both growth and

inflation at the same time. But, again, it is assumed that price stability cannot be

compromised, and hence the idea of indirectly influencing and managing the exchange rate in

order to promote growth has to take the backseat (see Kaltenbrunner and Paincera 2015 for a

discussion). Fiscal policy and exchange rate management are, by assumption, subordinated to

interest rate-based inflation targeting.

3.2 The scope for policy coordination

What is the scope for countries to improve upon the non-cooperative (Cournot-Nash) outcome

by agreeing to a joint policy package that is mutually beneficial, in this narrowly

circumscribed (“rule-based”) framework? To assess this scope, I use the parameter values

given in Table 4 to calibrate the initial non-cooperative (long-run) equilibrium and to—next—

explore the rationale for policy cooperation. In the calibrated initial equilibrium, in which the

two countries do not coordinate their macro policy decisions, the two economies grow at a

trend growth rate of 1% per year; their inflation is kept constant at 0.3% at real interest rates

of 2%; and the exchange rate is constant. This non-cooperative outcome (“pay-off”) is the

“no-stimulus / no-stimulus” scenario in Table 5. Although it is straightforward to solve the

two-country model and derive the reduced-form solution, the algebra is somewhat wearisome

and hence relegated to the Appendix. Let us now consider the scope for and consequences of

international policy coordination—under the assumptions that the central banks can control

their interest rates in order to keep inflation at the given target (as in Taylor 2013).

18

Table 5

Pay-off matrix: fiscal stimulus

Country 2

No stimulus Stimulus

Country 1

No stimulus 1.00 / 1.00 0.57 / 1.43

Stimulus 1.43 / 0.57 1.00 / 1.00

Source: see Appendix.

To do so, suppose that country 1 unilaterally opts for fiscal stimulus; specifically, it is

assumed that g = 2. In Figure 3, fiscal stimulus is reflected by the upward shift of country 1’s

IS-curve. The curve representing the “non-accelerating inflation” rate of economic growth

(derived from equation (2)) does not shift.3 Country 2 does not respond and passively adjusts

its policies to the changed international conditions. Not surprisingly, fiscal expansion drives

up demand in country 1 (through (1)), putting upward pressure on prices (via (2)) and forcing

its central bank to raise the interest rate (as per its MPR withp = 0.3%). Consequently, r > r*

and capital will flow toward country 1. This causes a currency appreciation (ε = ─0.43%,

through (3)) which helps to reduce inflationary pressures in country 1 (basically by

“exporting” inflation to country 2) and thus allows for a more moderate rise in r. (In practice,

but not in this model, the appreciation could kick in a process of deindustrialization and

“structural decline”, especially in the early-industrializing EDEs; see Storm and Naastepad

2005; Akyüz 2014). In effect, the policy change is expansionary for country 1, as economic

growth is raised from 1% to 1.43% (at p and a much higher interest rate of 5.2%). In Figure

3, this expansion means moving up from equilibrium A to B. The higher growth of country 1

leads to higher demand for imports produced by country 2 via 4µ . But this growth-enhancing

trade-spillover is more than offset by the other cross-border impacts of country 1’s stimulus

package. Specifically, country 2 experiences a capital outflow and concomitant currency

3 Note that in the closed economy, fiscal policy is ineffective, since the curve for the “non-accelerating inflation” rate of economic growth in Figure 3 would be just the vertical Phillips curve. Fiscal policy only has real effects in the present model, because of the international free-riding mechanism (as explained in the text).

19

depreciation which raises its exports (via (1*)) but also inflation (via (2*)). Country 2’s

central bank is forced (by way of its MPR) to raise r* so as to keep 3.0* =p , and this

inevitably reduces growth (Taylor 1985). As a result, country 2’s growth declines from 1% to

0.57% at constant inflation and a much increased interest rate r* of 4.8%. This is the pay-off

for the off-diagonal “stimulus / no-stimulus” scenario(-s) in Table 5.

Figure 3

Country 1: Effects of Fiscal Stimulus

rate of interest

“non-accelerating inflation” rate of

economic growth of country 1

B

r

A

IS-curve of country 1

y1 y2 economic growth

We can now see that the absence of coordination may give rise to free-riding

behaviour: country 1’s macro stimulus pays off, but does so at the cost of macroeconomic

performance in country 2. This points to a beggar-thy-neighbour, or zero-sum, policy conflict

in a Cournot-Nash setting (Ostry and Ghosh 2015). Clearly, one cannot expect country 2 to

remain passive—it will “retaliate”, for instance by following the lead of country 1 in “tit-for-

tat” fashion by opting for a similar fiscal stimulus, thus raising g* to 2. However, in the

resulting new equilibrium, there will be complete crowding out of the fiscal stimulus, as both

(identical) countries end up growing at a rate of 1%—with actual inflation at the target and

20

interest rates at 8% in both economies. In terms of Figure 3, it means that the curve

representing the “non-accelerating inflation” rate of economic growth would become a

vertical curve at y1—analogous to the NCM’s vertical Phillips-curve (Storm and Naastepad

2015b). It will be clear from Table 5 that neither country has a dominant strategy, but each

country would want to coordinate with the other to avoid the (off-diagonal) free-riding

outcomes. If one accepts the overwhelming weight given to stable inflation and subscribes to

the view that policy should be rule-based, this “coordination game” does suggest that both

countries should refrain from fiscal stimulus, because simultaneous fiscal expansion does not

pay off in terms of higher growth. This particular result actually confirms the NCM’s default

position on international policy coordination in “normal times”: because as the effects of

macroeconomic policy spillovers can be neutralized by an appropriate macro policy in each

country, policymakers do not have systematic incentives to deviate from the initial “no-

stimulus / no-stimulus” equilibrium, and hence should stick to their own “optimal” monetary

and fiscal policy rules (Oudiz and Sachs 1984; Taylor 2013). “We will not revisit the question

of international monetary policy coordination during normal times,” write Benes et al. (2013,

p. 5), “where we expect our model to yield the same results as the [mainstream] literature.”

The NCM consensus that international (monetary policy) coordination is a second-order

problem in normal (“quiet”) times is buttressed by a plethora of analyses of the manifold

practical-political obstacles to coordination, which “explain” why we do not see more than

episodic (emergency) coordination. Key obstacles to global policy cooperation include (Ostry

and Ghosh 2015):

1. the absence of (credible) international (quid-pro-quo) sanctions to underpin the inherently fragile (Cournot-Nash) cooperative agreement by making it prohibitively costly for countries to renege;

2. the likelihood of asymmetric gains and losses from cooperation (i.c. small economies are likely to benefit more from coordination than large economies) and the possibility of free-riding behaviour by (small) countries which are not part of the cooperation;

3. myopia on the part of (national) policymakers who may fail to perceive the potential welfare gains from coordination, while only seeing the cost of giving up part of (or adjusting) domestic policy autonomy (Obstfeld and Rogoff 2002); and

4. there may be too much uncertainty about the (positive and negative) cross-border effects of macro policies (contemporaneous and lagged) to enable meaningful negotiations over how to share the benefits and the burdens of cooperation in a changing global environment—effective international fine tuning is simply

21

unworkable, especially when there is no agreement about the “correct” model for the global economy.

There is no doubt that these factors constitute a hindrance to international macroeconomic

policy coordination, but these same obstacles have not been insurmountable in the case of

cooperation in trade (World Trade Organization), financial regulation (Financial Stability

Board), and international liquidity provision (IMF financing & central bank swap lines).

Nevertheless, in combination with the view that spillovers from monetary policy are only

second-order, these practical hindrances constitute a further disincentive to global

cooperation.

There, however, exists an obvious—but unmentioned—way out of this coordination

deadlock: both countries could agree to fiscal stimulus while simultaneously relaxing the

chokehold of inflation-targeting. If we assume, for instance, that g = g* = 2 while inflation

targetsp and *p are simultaneously raised to 0.5% (reflecting a more accommodative

monetary policy stance), then both economies could grow at 1.67% per year. Coordinated

fiscal stimulus, supported by monetary accommodation, would in other words constitute a

Pareto-improvement over the initial equilibrium—under the same restrictive model

assumptions as before. But this option is generally discarded, because the given inflation

target—in this example p = *p = 0.3%—is sacrosanct to the Monetarist dogma of the NCM:

after all, inflation targeting can only work if the central bank has a credible reputation on

controlling inflation (Arestis and Sawyer 2011). Tinkering with the inflation target can only

do damage to this hard-won reputation—and central-bank lore treats it as an Orwellian

thoughtcrime.4 Hence, barring monetary accommodation, both countries are stuck in the

deflationary long-run “no-stimulus / no-stimulus” equilibrium characterized by fiscal

4 However, of late, dissenting voices have been calling for an increase in the inflation target from 2% to 4%; see Ball (2014). Whelan (2013) writes: “I believe recent experience points to 2% being too low. … We know now that the liquidity trap is not a theoretical curiosity. Economies that operate at a 2% average rate of inflation are one recession away from the difficulties associated with falling into that trap. Set against these dangers, I don’t know of a single study that can explain how the social costs of a steady inflation rate of 3% or 4% would offset the reduced risk of deflation due to such a low target rate.”

22

tightening. Actual outcomes will be worse, if the inflation stabilization (atp ) is anchored to a

NAIRU that is high, as is true for most of the EU (Storm and Naastepad 2012).

3.3 International policy coordination in response to “shocks” or “crisis”

Within the NCM, the only instance in which one can legitimately call for international policy

coordination is the case in which a country suffers from an exogenous and unforeseen supply-

side shock. The introduction of such a ‘shock” is the only way in which this model, with

rational optimizing agents having perfect foresight and efficient (financial) markets, can be

kicked out of its stable long-run equilibrium position and into a delicate, not necessarily

“efficient” process of adjustment (back towards equilibrium, but prone to over-shooting),

because of some inertia or temporary maladjustment on the part of the model agents. It is

precisely during this adjustment process that global policy coordination can—in principle, at

least—make a positive difference by guiding the economies back to (trend) equilibrium at

lower cost than in an uncoordinated scenario, basically by shifting (or smoothing) output

losses over time (Ostry and Ghosh 2015). For some NCM authors (Canzoneri et al. 2005;

Taylor 1985, 2013), the imperative is to find “optimal rules” for global coordination, and one

result is that the optimal cooperative rule is relatively accommodative to inflation (compared

to the non-cooperative policy rules). Crucially, however, once the consequences of the shock

have passed, there is no need any more for coordination.

Even though the model of Table 4 does not have any dynamics, as it assumes

instantaneous and frictionless adjustment to equilibrium when shocked, it can be used to

illustrate the above argument (but arguably in a somewhat limited manner, as it cannot be

used to explore possible trade-offs over time). Let us assume that country 1 experiences a

sudden reversal of capital flows, due to which its currency goes down; I assume that Eσ = 1

and hence (in the two-country set-up), we get*Eσ = ─1. We first consider the default situation

of non-cooperation. The currency depreciation in country 1 drives up inflation (via equation

(2)), which motivates the central bank to increase the interest rate (from r = 2 to r = 2.4); the

higher interest rate may also serve the purpose of defending the exchange rate and re-attract

capital inflows. The higher interest rate depresses aggregate demand and reduces country 1’s

(trend) rate of growth to 0.86%. The opposite adjustments take place in country 2, which is

the beneficiary of higher capital inflows, a currency appreciation and an interest rate

23

reduction. Hence, for as long as the shock lasts, country 1 will be worse off, while country 2

is better off.

Table 6

Pay-Off Matrix:

Asymmetric external (inflationary) shock in country 1

Country 2

No coordination Coordination

Country 1 No coordination 0.86 / 1.14 ─

Coordination ─ 1.17 / 1.17

Note: The results are derived using the model in Table 4. It is assumed thatEσ = 1 and *Eσ =

─1. The concerted policy package consists of fiscal stimulus by country 1 (g is raised to 1.389) and a more accommodative monetary stance to inflation by country 2 ( *p = 0.4). Source: see Appendix.

The cooperative equilibrium in the NCM literature is obtained by assuming a global

planner who maximizes a weighted average of each country’s quadratic policy loss functions

to determine the “optimal” interest rates for the two countries (as in real-business cycle

models; see Taylor 1985, 2013; Ostry and Ghosh 2015). However, rather than imposing a

single global ruler who is looking for universally optimal rules for monetary policy

coordination but at the same time assumes away fiscal cooperation (as is also noted by Rogoff

2013), I have used the calibrated model to explore the possibility of coordinated outcomes,

based on fiscal cum monetary policy, which are Pareto-superior to the non-coordinated

scenario. The coordinated scenario appearing in Table 6 is based on fiscal stimulus by crisis-

struck country 1 (g is raised to 1.389) and a more accommodative monetary stance to inflation

by (benefiting) country 2 ( *p = 0.4). While I do not claim that this coordinated scenario

represents the global optimum, I note that the expansionary outcome is superior to the non-

cooperative situation. Helped by the monetary accommodation in country 2, country 1 has

enough fiscal space to (more than) offset the external shock—and the expansion of country 1

spills over into faster growth in country 2. Even though the model is much simplified, the role

played by monetary easing in country 2 does resonate with recent debates on the need for

joint quantitative easing in the current post-crisis secular stagnation. Bernanke (2013), for

example, has argued that coordinated QE in the G7 constitutes a positive-sum scenario,

24

because the cross-border impacts to trading partners created by higher domestic demands, in

his view, outweigh the (smaller) exchange appreciations that come from the monetary easing

abroad. Taylor (2013) disagrees—he argues that the positive effects of QE, which he

considers a violation of rules-based monetary policy, are exaggerated and smaller than

negative exchange rate gyrations. However, both positions in this debate neglect the fact that

there is a case for greater coordination of fiscal policy as well (Rogoff 2013; Fatàs and

Summers 2015)—as shown in Table 6, and of course, the fiscal cooperation and monetary

coordination are strongly interlinked. It is one of the weakest points in the NCM—and

particularly so in the current conjuncture.

3.4 Global policy coordination: an assessment of the NCM approach

The NCM treats international monetary policy coordination as a second-order problem in

normal (“quiet”) times, but does accept that there is a temporary case for coordination in crisis

periods as it may help smooth the adjustment process (Ostry and Ghosh 2015)—and this

‘temporary case’ for monetary policy coordination is even stronger in the current global

conjuncture (of the Great Recession) in which interest rates in (some) countries have hit the

zero-lower bound and central banks are forced to resort to unconventional monetary policy

(i.c. QE) with large and unknown cross-border spillover impact (see Subacchi and van den

Noord 2012). In all instances, however, fiscal policy coordination is off the cards. This NCM

consensus reflects, as opined by Blanchard (2008) in a rather self-congratulatory manner, a

remarkable degree of ‘convergence of vision’—or ‘group think’— among the professional

community of modern macroeconomists in which the earlier cantankerous debates between

different schools of thought have (supposedly) subsided. But what Blanchard does not

mention is that this convergence of vision, or synthesis of New-Classical and New-Keynesian

approaches, is based, in general as well as specifically for the issue of international

macroeconomic policy coordination, on narrowing down the model to simple, restricted and

rather well-defined theoretical examples in which the benefits of ‘policy activism’ (which

includes coordination) are negligible by assumption. This is what, I hope, the preceding

discussion of the NCM approach has made clear. Specifically, the following—

consequential—assumptions need to be scrutinized.

Assumption 1: the NAIRU exists as well as an associated ‘natural rate’ of economic growth

(presupposing, in turn, that all agents in the system have rational expectations). It then follows

25

that the central bank best serves the public good by following a MPR so as to keep inflation

constant. The immediate corollary is that discretionary fiscal policy space is effectively non-

existent, as fiscal stimulus (as a deviation from the fiscal rule) will be crowded out by the

MPR. Fiscal policy is, and I can quote Rogoff (2013) here, “assumed away” and this is done

in remarkably customarily:

• “Eventually [….] the real interest rate rises; in the long run private spending is completely crowded out by government spending as in any model with price adjustment”, pace Taylor (1985, p. 59) (italics added).

• “Governments in each country balance their budgets …”, and can therefore be neglected Canzoneri et al. 2005, p. 14, fn 14).

• “A fiscal initiative at this juncture could prove quite counterproductive, if (for example) it provided economic stimulus at the wrong time or compromised fiscal discipline in the long term”, cautioned Fed chairman Bernanke (2008) at the height of the financial crash.

• “…. one can think of alternative policy instruments— most obviously fiscal policy—that may help sustain domestic demand in the home country. However, this policy strategy may not be viable if there is a need for fiscal policy adjustment to ensure debt sustainability”, write Blanchard and Milesi-Feretti (2011, p. 15) so as to discard fiscal policy from their analysis.

• “For the sake of simplicity and in line with Blanchard-Milesi-Feretti’s assumption, we assume that fiscal policy is constrained by sustainability concerns and therefore not available as a free instrument,” explain Subacchi and van den Noord (2012, p. 448, fn 12).

• “… all that is necessary as a matter of active policy in normal times is appropriate movements of interest rates, and the operation of disciplined fiscal policies to ensure that government budget deficits are balanced over the longer term.” (Adam, Subacchi and Vines 2012, p. 399).

As a result, the discourse on international macroeconomic policy coordination has been

generally narrowed down to a discussion on the desirability of monetary policy coordination

by (technocratic) central banks in times of turmoil.5 Clearly, the deliberate neglect of fiscal

policy (coordination) is a costly mistake, because fiscal policy does have permanent effects—

as is acknowledged by Keynesian economists (Lavoie 2015), but also a few mainstream

studies (Fatás and Summers 2015).

5 Benes et al. (2013) are a prominent exception, as they do argue strongly in favour of international fiscal policy coordination, albeit temporarily.

26

Assumption 2: open international capital and goods market operate efficiently and are

integrated to a very high degree; capital controls are absent and capital mobility is high.

Floating exchange rates will then ensure that the (two) interest rates are consistent. A first

point to note is that if there are significant international capital market imperfections (as is

true in reality), the case for (monetary) policy coordination becomes stronger even if one

stays with the NCM paradigm (Obstfeld and Rogoff 2002). Secondly, and more importantly,

this assumption implies is that the exchange rate is no longer a policy instrument (to support a

country’s economic development)—exchange rate determination is left to (international)

market forces, and this not only increases the exposure of especially the EDEs to the risk of

destabilizing exchange rate gyrations in response to speculative capital in- and outflows (BIS

2013; Kaltenbrunner and Painceira 2015), but in combination with inflation targeting, it also

further drastically shrinks (developmental) policy space (Epstein and Yeldan 2010; Akyüz

2014). For John Maynard Keynes, ensuring macroeconomic stability and guaranteeing

adequate domestic macroeconomic policy autonomy is the main issue: “[i]n my view, the

whole management of the domestic economy depends upon being free to have the appropriate

rate of interest without reference to the rates prevailing elsewhere in the world. Capital control

is a corollary of this” (cited in Bortz 2016). Capital controls can also be justified (in

mainstream thinking) as measures to correct for global market failures caused by imperfect

information, (financial) contagion and uncertainty (Stiglitz 2010; see Gallagher 2012 for the

Keynesian literature). Keynes’ view stands in sharp relief against the NCM, which is

summarized by Taylor (2013, p. 19): “…capital controls create market distortions and may

lead to instability as borrowers and lenders try to circumvent them and policymakers seek

even more controls to prevent the circumventions. […] Capital controls also conflict with the

goal of a more integrated global economy and higher long-term economic growth.” The latter

claim that the costs of capital controls outweigh their benefits is premature, as the debate on

the issue for the EDEs is far from settled (Forbes 2008).

Assumption 3: Aggregate demand is a non-issue in this Say’s Law-world, and this is true as

well for income distribution. The ‘forcing’ assumption that produces this result and makes

demand policy ineffective is, of course, the existence of the NAIRU and a ‘constant-inflation-

rate’ of economic growth (as in Figure 3 and already postulated above). Fiscal policy, income

policies, employment policies, etc. are all—by construction of the model—ineffective.

Distributional changes in terms of changes in the wage (profit) share may matter in the short

27

run, but not in the long run, when agents are no longer misinformed about prices and the

monetary authority has stabilized inflation at the (long-run) target (Storm and Naastepad

2012, 2015b). This is another clear case of defining away a major policy problem.

Assumption 4: The international transmission mechanisms of macro policy operate primarily

through flow variables (i.e. exports and imports of goods and capital flows which affect the

exchange rate and the interest rate), while the external balance-sheet (or stock) dimension of

cross-border interdependence is of only second-order importance and can be neglected. This

amounts to ‘gross negligence’, because it means no attention is given to the structure of a

country’s gross external balance sheets (and leverage), and the risks, the maturity mismatches

and other vulnerabilities which have been accumulated in its gross external liabilities. Al-

Saffar et al. (2013) provide a detailed account of the structure of gross external balance sheets

has indeed made countries (more or less) vulnerable to financial imbalances and shocks (see

also Akyüz 2014; IMF 2015; Bortz 2016). The simple (accounting) point is that with open

capital markets, countries are also borrowing from abroad to finance investment opportunities

abroad—hence, even with a balanced current account, there can be an accumulation of foreign

debt which is used to finance an equal amount of (financial) investment abroad. “A country

can be vulnerable to rollover risk on its foreign liabilities even without a current account

deficit,” conclude Al-Saffar et al. (2013, p. 5). In addition to the increased risk of a sudden

funding stop, gross financial flows are often associated with domestic credit booms and

unsustainable asset price inflation (as in Turkey for instance), which increase financial

fragility and vulnerability. Hence, when it comes to the cross-border transmission

mechanisms for macroeconomic policy the NCM appears to be missing most of the action.

Assumption 5: There is only risk (as there is perfect foresight), but no (primary or secondary)

uncertainty. This implies that all possible futures not only are already known prospectively,

but also (in a clear case of circular reasoning) are part of the explanation of the processes that

supposedly bring them about. By discarding the presence of unknown unknowns, the NCM

reduces—without further ado—the problem of policy coordination under uncertainty to the

(mathematically) tractable problem of ‘optimal’ policy coordination under objective

28

probabilistic risk.6 In this probabilistic setting, in which economic decisions can be based on a

known probability density function, we need not distinguish between our (objective)

expectations about the future and the confidence with which we hold them. Notions of

“business confidence” or “consumer confidence” have therefore no meaning in this NCM

world, even though such notions are crucial in the real—fundamentally uncertain—world. But

as argued by Keynes (1936), because the future is not known, all that investors and consumers

can do is transforming subjective bets into seemingly objective probabilities, inventing a

rational, calculable world which they take to mirror the real one. Keynes (1937, p. 114)

argued that people will rely on social conventions (as a heuristic device) to make their

decisions:

“(1) We assume that the present is a much more serviceable guide to the future than a

candid examination of past experiences would show it to have been hitherto. In other

words we largely ignore the prospect of future changes about the actual character of

which we know nothing.

(2) We assume that the existing state of opinion as expressed in prices and the

character of existing output is based on a correct summing up of future prospects, so

that we can accept it as such unless and until something new and relevant comes in to

the picture.

(3) Knowing that our own individual judgment is worthless, we endeavour to fall

back on the judgment of the rest of the world which is perhaps better informed. That

is, we endeavour to conform with the behaviour of the majority on average. The

psychology of a society of individuals each of whom is endeavouring to copy the

others leads to what we may strictly term a conventional judgment.”

Conventions help create the confidence that expectations thus formed have a degree of

meaningfulness or validity, sufficient to sustain investment and consumption decisions.

Conventions thus impart (conditional) order and Keynes thought it reasonable to follow them

(Crotty 1994). In this set-up, global policy coordination can help “anchor” and “synchronize”

6 The complexities that remain, all have to do with the Nash-dilemma of how to come to a stable credible agreement between two or more self-interested parties (Adam, Subacchi and Vines 2012; Ostry and Ghosh 2015).

29

conventional expectations by helping to reduce—what Koopmans (1957) called—secondary

uncertainty, i.e. the uncertainty’ arising out of a lack of knowledge about the actions and

concurrent plans of other economic actors in our decentralized global economic system. It is

in this “anchoring” and “synchronizing” of expectations and confidence that the potentially

most significant benefits of global macroeconomic policy coordination may lie. It is exactly

this potentially substantial benefit from policy coordination that is ignored by the NCM by

assumption.

In sum: there is a clear need for a reassessment of the NCM conclusion that international

policy coordination is a mere second-order problem. This reassessment should be based on a

more realistic (or realist) and policy-relevant approach to the issue of global policy

coordination, which departs from a monetary-production economy, acknowledges

uncertainty, allows more realistic (long-run) roles for aggregate demand, fiscal policy and

income distribution, and incorporates the balance-sheet (stock) dimension of global

integration in the analysis in a stock-flow-consistent (SFC) manner. The focus should not be

restricted (on à priori grounds) to monetary policy coordination by omnipotent central banks,

but on creating space for economic development, especially in the EDEs. The next section

explores these options.

4. International macroeconomic policy coordination: UNCTAD’s GPM

The key rationale for international macroeconomic policy coordination lies in its capacity to

reduce “secondary uncertainty” and at the same time to build up confidence around a shared

vision on the world’s major policy challenges and options, or what Keynes has called

“conventional expectations” of the uncertain future. Global policy coordination should be

interpreted as an exercise in “indicative planning” (Massé 1963; Meade 1970) or

“instrumental inference” (Lowe 1977), in that a coordinated and deliberative exploration of

the future acts as an informational substitute for forward markets that do not exist; in a more

Keynesian interpretation, it serves the purpose of strengthening the confidence of (real

economy) investors in a reflexive manner (Davidson 2009, pp. 46-7). What people think

about the market can affect and alter the future path the market takes—and hence the

“management of expectations” itself becomes instrumental to achieving stable growth. To

make it work, what is needed first and foremost is a shared (global) policy analysis—

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conflicting views, for example about the need for fiscal stimulus and/or monetary policy

accommodation, make it impossible to build up confidence and stabilize the global

conjuncture. This means that the first step in a long road toward more effective global policy

coordination is to have an instrument—a global policy model—which can be used to

realistically scrutinize the benefits and costs of a scenario of no-policy coordination and to

identify acceptable alternative policy packages which (might) increase global welfare. The G-

20 MAP has already given the IMF the additional task of pointing G-20 countries towards

policy adjustments which they consider to be welfare-improving (Adam et al. 2012), and IMF

economists have started arguing in favour of the IMF taking on the role as a “neutral

assessor” who “would highlight policy packages that would make each party better off”

(Ostry and Ghosh 2015, p. 27). However, the IMF is an unlikely candidate for a “credible and

neutral assessor”, as the EDEs have deep-seated misgivings about the governance and policies

of IMF, as is well known (Stiglitz 2002) and explained by Akyüz (2014) in the context of the

debate on sovereign debt restructuring. The IMF global models, in addition, suffer from many

of the weaknesses identified in Section 3. I want to propose, therefore, that UNCTAD takes

on the role of neutral assessor (rather than the IMF), using its Global Policy Model (UN 2009;

Cripps and Izurieta 2014) as the instrument to explore the potential for global policy

cooperation and to build up confidence in a shared vision. This section will hence evaluate the

usefulness of the UN Global Policy Model (UN-GPM) from the vantage point of global

policy coordination.7

4.1 UN-GPM: overview

The UN-GPM is a dynamic stock-flow-consistent (SFC) macroeconomic model which

includes sixteen G-20 member countries and a further nine country groups, covering the

world economy as a whole. It is explicitly not a forecasting model (although the model

coefficients are econometrically estimated using data for the period 1980-2008, see UN

(2009)), but an instrument for dynamic “what-if” scenario analysis in support of (global)

policy design (UN 2009, p. 3). Its five defining features in my view are (drawing on Cripps

and Izurieta 2014):

7 I will not assess the organization of the model’s database, the (panel-data) econometric estimation of the model parameters, and detailed model structure in terms of countries, sectors and commodities (see UN 2009; Cripps and Izurieta 2014).

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• the strict national accounting consistency across all countries, which its analytical framework enforces on all flow and stock variables;

• the demand-determined nature of (national and global) economic activity, which in turn is affected endogenously by changes in employment, income distribution and (national and global) financial conditions;

• the endogenous determination of the functional (wags-profit) distribution of income in combination with endogenous labour productivity growth (à la Kaldor-Verdoorn);

• stock-flow consistency, which means that the flow-of-funds accounts and balance sheets of the main institutions are made explicit and dynamically integrated into the model by means of accounting rules and behavioural relations (stock-flow norms); changes in income and expenditure of the private sector, government and national economies are fully mapped into changes in net lending or borrowing positions of these sectors; and

• gross flows of financial assets are mostly determined within financial markets; but importantly, gross financial positions feed back into real-economy decision-making concerning savings, investment, fiscal policy and exchange rates.

From this listing it is clear that the UN-GPM does not share most of the restrictive

assumptions of the NCM (listed in Section 3). Specifically,

• the UN-GPM does not presuppose a ‘natural rate’ of growth nor a NAIRU, but instead includes a (weak) Phillips-curve-type trade-off between growth and (cost-push) inflation. This is illustrated in the Impact Tables (UN 2009, pp. 69-97): for instance, an increase of 1% in GDP will generate a short-run increase in the (goods) inflation rate by 0.22% in U.S.A. and 0.15% in China. The implied growth-inflation trade-off is not very steep, which means there is little need to raise interest rates and there is no significant ‘crowding out’ of fiscal stimulus. Short-run (first-year) fiscal multipliers consequently exceed 1 in all countries and are frequently greater than 1.5; the fiscal multiplier for the U.S. takes a value of 1.58, for Brazil of 1.84, for China of 1.76 and for India of 1.65 (UNCTAD 2013, Table 1.4). Debt-financed fiscal stimulus is therefore effective and could potentially be self-financing (especially if several countries pursued expansionary policies simultaneously), also in the long run (as has been rediscovered by Fatás and Summers 2015); I further note that fiscal policy follows a ‘countercyclical rule’ and thus helps to stabilize the growth path.

• the UN-GPM does assume that global financial markets match current account flows with the capital account and reserves; hence international capital mobility is high and financial markets operate efficiently. However, in addition to this accumulation of net external financial assets, the UN-GPM also models external assets and liabilities on a gross basis. It assumes that the basic long-run drivers of gross financial positions are the wealth objectives of a country’s private sector (Cripps et al. 2011). Specifically, if the private sector’s wealth objectives are not satisfied domestically (by the rising

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value of real capital or government debt), a country will accumulate external assets. This means that “the private sector becomes the arbiter of domestic credit creation and external financial balances,” write Cripps, Izurieta and Singh (2011, p. 237), which presents “ongoing risks of instability ….” Private sector decisions thus drive external gross capital flows and determine external balance sheet positions.

• the UN-GPM does not assume that the exchange rate is determined by either the flow of net exports or the net capital inflow (as in equation (3) of the NCM model), but instead assumes that the real exchange responds to relative income per capita and GDP growth (as proxy for investor confidence and profit expectations). In a proposed extension of the UN-GPM, the real exchange rate will be influenced by two stock variables in addition—the ratio of gross external assets to GDP and a 'liquidity' measure defined as the ratio of banking and reserve assets to banking and portfolio liabilities.8 This will mean that gross international positions do impact the exchange rate, but (unlike in the NCM approach) the estimated coefficients for these balance-sheet feedback effects are too small to prevent the accumulation on increasingly unbalanced external positions (see UN 2009, p. 9, fn. 3).

• the UN-GPM does not assume away the problem of aggregate demand, but instead highlights the major (short- and long-term) consequences on growth, inflation, trade, employment and income distribution of changes in demand. The critical role of distribution and demand is brought out in sharp relief by in two scenario studies using the UN-GPM. The first one, by Cripps, Izurieta and Singh (2011), presents a “Global Development Scenario” in which a coordinated fiscal stimulus, combined with active exchange rate management and coordinated energy-saving and ‘greening’ of the economy, raises global GDP growth while reducing debts and current account imbalances. The second scenario study was performed by Capaldo (2014), who applies the UN-GPM to assess the macroeconomic impact of the Transatlantic Trade and Investment Partnership (TTIP) in the EU and the USA. Capaldo’s results stand in stark contrast to NCM-like model analyses (e.g. CEPR 2013; CEPII 2013), which impose Say’s Law and presuppose full employment. According to Capaldo’s simulation results, TTIP would lead to net losses of GDP, jobs, labour income and government revenue for the EU, while its financial imbalances would increase. The explanation for these results is that TTIP leads to trade diversion rather than trade creation—specifically, intra-EU trade in lower value-added products (in which the EU is relatively uncompetitive) declines as it is crowded out by imports of U.S. goods; EU exports of higher value-added goods increase. The industrial restructuring leads to a change in the functional distribution of income and, specifically, a decline in the wage share (and a rise in the profit share). This reduces domestic demand. The aggregate (net) impact on GDP, jobs and government revenue of the decline in low

8 Personal communication from Francis Cripps (email 26-11-2015).

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value-added exports, the rise in higher value-added exports and the decline in domestic demand (due to the fall in the wage share) is negative. “At a minimum,” Capaldo (2014, p. 1) concludes, “this shows that official studies [of TTIP] do not offer a solid basis for an informed decision on TTIP.”

• the UN-GPM does not presuppose that all futures are already known and optimizing agents have perfect foresight, but importantly models economic behaviour in terms of ‘conventional’ decision-making in the Keynesian sense. For example, private consumption is defined as the difference between private disposable income and private savings. The private savings propensity in turn depends on the growth of private income and the growth of private wealth—which is suggestive of conventional decision-making (under uncertainty). In addition, the overall saving rate increases (and consumption drops off) as the functional distribution of income shifts away from labour (UN 2009, p. 9). Private investment depends on the real interest rate and external capital flows, but also follows a Keynesian accelerator response to GDP growth—which implies that firms expect rising profits, increased sales and greater use of existing production capacity. The accelerator model is self-reinforcing (or ‘reflexive’) in the sense that higher growth raises business confidence, encourages firms to expand which leads to even higher growth and even stronger business confidence. Savings and investment decisions are therefore not based on forward-looking optimization by a representative agent who already knows the future, but instead more reasonably grounded in conventional behaviour in conditions of fundamental uncertainty.

The UN-GPM model, as I will argue in more detail below, can be used for the type of

‘indicative planning’, for which I outlined the need above and which I think is necessary for

deliberative international macroeconomic policy coordination. The UN-GPM model features

“add factors” which can be used to conditionally activate (or combine) policy instruments in a

deliberative fashion—handles which can be used in policy design. To make this case, I will

first assess the impacts for global policy coordination in the relevant UN-GPM scenario

analyses.

4.2 Global policy coordination in the UN-GPM

In the Annex to Chapter 1, UNCTAD (2013) compares two alternative scenarios for the world

economy to the un-coordinated business-as-usual (BAU) scenario, based on simulations using

the UN-GPM. This scenario analysis was a follow-up to earlier studies which compared the

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macroeconomic effects of uncoordinated and coordinated global stimuli (UN 2009A) and

looked into the risks of an early retreat from macroeconomic stimulus following the financial

crisis of 2007-8 (UN 2009B). UNCTAD (2013) defines the following two scenarios (relative

to BAU):

• scenario A (“full global coordination”): all countries participate in a global fiscal stimulus (in the form of public investment growth), income redistribution in favour of wage earners, and supportive (accommodating) monetary policy. Surplus countries make a greater contribution than deficit countries through measures bolstering domestic demand and exchange rates are actively managed so as to reduce global imbalances.

• scenario B (“South-South cooperation”): only the EDEs participate in the fiscal stimulus, income redistribution and supportive monetary programme. The developed countries continue their BAU policies of austerity, while “free riding” on the expansion of the EDEs.

To facilitate a comparison of UNCTAD’s (2013) scenario analysis with that of the NCM

approach given by Table 5, the UN-GPM scenario outcomes have been reframed in the 2x2

pay-off matrix of Table 7. The pay-offs are defined as the average annual growth rates of

private consumption for the developed countries, the EDEs and the world economy as a

whole during the simulation period 2013-2030. In the BAU case, private consumption in the

world economy is projected to grow at 3% per annum—consumption growth in the EDEs is

4.8% per year as compared to private consumption growth in the developed (OECD)

countries of 1.6% per year. As is clear from Table 7, in the UN-GPM ‘expansionary’

coordination—whether global or unilaterally South-South—would lead to significantly

superior outcomes (in terms of consumption growth) for the EDEs and the developed

countries as compared to the baseline. This stands in contrast to the zero-sum nature of

‘expansionary’ coordination in the canonical NCM model, as shown in Table 5, which is, as I

have argued, an artefact brought about by mechanically imposing a rigid inflation constraint

(something which in turn is theoretically ‘justified’ by assuming that macro-performance is

anchored at the NAIRU). In the UN-GPM, in contrast, there is no NAIRU and (cost-push)

inflation is allowed to increase as accommodative central banks raise (policy) interest rates

much less than is needed to keep inflation at a given target (see UN 2009, Table A.1.3 for

evidence on the interest rate increases induced by fiscal stimulus). As a result, fiscal stimulus

does work itself out through domestic and cross-border multiplier processes. Cross-border

growth spill-overs are substantial in the UN-GPM: based on scenario B, we can gauge that a

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one percentage point increase in the growth of the EDEs raises the long-term growth rate of

the developed economies by 0.25 percentage points (which is comparable to IMF estimates

appearing in Table 1). Similarly, as a rough approximation, we could claim that a one

percentage point increase in the growth of the developed countries raises the long-term

growth rate of the EDEs by 1.4 percentage points (which would be about twice as large as the

spillover estimates of the IMF in Table 1).9 While this is certainly an overestimation, it does

suggest that growth spillovers will be more significant in a demand-determined system.

Table 7

Pay-off matrix: expansionary coordination in UN-GPM

Developed countries BAU Coordination

EDEs

BAU 4.8 / 1.6 (3.0)

─

Coordination

Scenario B 6.4 / 2.0

(4.0)

Scenario A 8.1 / 3.2

(5.5)

Note: Pay-offs are given in terms of annual average growth rates of private consumption during 2013-2030. Average growth rates for the EDEs have been calculated as the weighted average consumption growth (2013-2030) for Africa, Latin America and the Caribbean, West Asia, East, South and South-East Asia (excl. China and India), China and India; the weights are their shares in global GDP. Figures within brackets are the growth rates of private consumption for the world economy as a whole. Source: author’s calculations based on UNCTAD (2013), Tables 1.6 and 1.A.1.

Scenario A (“full global coordination”) is very expansionary and most of the growth

acceleration is driven by higher consumption demand, which is itself due to a ‘policy

engineered’ increase in the wage share (and concomitant decline in the profit share). Higher

9 In scenario A, consumption growth in the EDEs increases by 3.3 percentage points; in scenario B, the growth increase is 1.6 percentage points. This suggests that the difference (1.7 percentage points) is due to direct and indirect cross-border spillovers. For the developed countries, consumption growth increases by 3.2 percentage in scenario A and 0.4 percentage points in scenario B. The difference of 1.2 percentage points is then largely due to domestic stimulus. The spillover effect from developed countries to EDEs is then calculated as the ratio of 1.7 to 1.2.

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aggregate demand growth feeds back into faster technical progress and productivity growth

(through the Kaldor-Verdoorn effect) and higher private investment, which responds

positively to higher capacity utilization. The resulting Kaldor-Myrdal process of cumulative

causation explains the substantial step-up in growth, and in consumption and employment.

Critically, the strategy proves to be self-financing (almost in the Kaleckian sense of ‘financing

economic development’) as robust growth raises tax revenues and actually strengthens

governments’ fiscal position; more broadly, private and public indebtedness (relative to GDP)

goes down (as is shown also in UN 2009). Global current account imbalances are reduced, as

surplus countries are raising domestic demand and imports more than the deficit countries

(UNCTAD 2013, chart 1.A.3). Scenario B (“South-South cooperation”) is clearly superior to

BAU, but inferior to the global expansion of scenario A. Nevertheless, UN-GPM estimates

that a go-it-alone fiscal stimulus by the EDEs does raise growth and employment worldwide,

through a similar process of cumulative causation. Regional cooperation is a sensible strategy

for the EDEs, since its growth pay-offs are likely substantial. However, EDE growth is lower

(because of the harsher external environment, created by the non-cooperative stance of the

developed countries), and the fiscal position of most EDEs deteriorates vis-à-vis BAU—this

suggests scenario B carries more risks than scenario A. The ‘free-riding’ developed countries,

on the other hand, experience a significant ‘windfall’ improvement in their fiscal position, as

a result of higher global growth. The substantive fiscal spillovers of EDEs’ growth

documented by UN-GPM do illustrate the point that in today’s integrated world system,

policy coordination (with the EDEs) is in the (self) interest of the rich countries. In

conclusion, according to the UN-GPM simulations, global policy coordination in the sphere

of fiscal and monetary policy, exchange rate management and capital account management

would lead to significantly improved global outcomes—not just faster growth, but also an

enlargement of the ‘space’ for the economic development of the EDEs.

5. UN-GPM: strengths, challenges, opportunities and threats

The first version of the UN-GPM was created in 2007 by the Department of Economic and

Social Affairs of the United Nations in 2007, drawing heavily on earlier global models

developed by Francis Cripps (Godley and Cripps 1976). The UN-GPM is in a continuous

process of further development, refinement and expansion, and is currently in its incarnation

5.c. In which direction should the UN-GPM be developed? To answer this question, I assess

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the main strengths and possible challenges of the UN-GPM (from the perspective of the

desirability of global policy coordination) and try to chart the major threats to the model as

well as promising opportunities for further development and policy analysis.

Strengths

The strengths of UN-GPM exist in:

(a) the realism of its key assumptions governing private investment, consumption, trade

and financial portfolio decisions (which all add up to economic activity being demand-

determined), which ensure that the model outcomes are eminently policy-relevant,

feasible and ‘real’. To illustrate, the fiscal multipliers of UN-GPM (which fall within

the range between 1.30 and 2) are in line with recent IMF estimates of fiscal

multipliers (Blanchard and Leigh 2013) as well as even more recent estimates by Fatás

and Summers (2015, pp. 21-22), who report a long-run fiscal multiplier of 1.6-1.7 for

the Euro area. This indicates that the UN-GPM policy scenarios reported in Table 7

are perfectly plausible.

(b) the national-accounting and stock-flow consistency of its analytical framework for the

world economy. The advantages of the SFC approach have been clearly outlined by

Marc Lavoie (2015) and need no further elaboration here: any sensible

macroeconomist worth the name would subscribe to the view that macro policymakers

cannot continue to neglect the flow-of-funds and balance sheet dimensions of the

growth process. And the IMF has followed the UN-GPM in developing SFC models,

as for instance the Global Integrated Monetary and Fiscal Model (GIMF) by Benes et

al. (2013). But whereas the UN-GPM is capable of describing a total of 25 countries

and groups (including sixteen G20 countries), the GIMF is restricted to only 6

countries/regions.

(c) its recognition that balance-sheet positions feed back into the circular flow of incomes

through their impact on savings, investment, exchange rates and interest rates. The

financial crisis of 2008 and its aftermath have made the critical importance of such

feedback effects self-evident—and Richard Koo’s (2013) characterization of our

current predicament of secular stagnation as a “balance-sheet deleverage” recession is

buttressing this point. Using data for 24 OECD countries and Taiwan (1980-2011),

IMF (2012) concludes that housing bubbles fueled by larger household debts tend to

38

be followed by longer-lasting and deeper declines in household consumption. As

already mentioned, Akyüz (2014) highlights the heightened vulnerability of the EDEs

because of the massive expansion of their external balance sheets. Again, the UN-

GPM is right on target.

(d) the significant role it attributes to (changes in) the functional distribution of incomes in

influencing both the pattern and rate of economic growth over time; according to the

UN-GPM a more egalitarian distribution of incomes is not just consistent with higher

global growth, but actually helps to bring it about (UNCTAD 2013). This is a finding

endorsed not only in recent academic research by Lysandrou (2011), Onaran and

Galanis (2014), Stiglitz (2014), Storm and Naastepad (2015) and Pichelmann (2015),

but also by new research by the OECD (2014), which concludes that “when income

inequality rises, economic growth falls” and “tackling inequality can make our

societies fairer and our economies stronger.” Clearly, the UN-GPM was well ahead of

the game in highlighting the critical interconnection between inequality, growth (or

stagnation) and crisis (Cripps et al. 2011; Capaldo 2014).

(e) its incorporation of endogenous technological progress (leading to endogenous labour

productivity growth), which makes the UN-GPM superior in terms of its supply-side

specification to most other global models which feature exogenous technical progress.

In older growth theory (going back to Marx, Hicks and Kaldor) as well as the so-called

modern theories of endogenous growth (Romer 1990) technological progress is argued

to be influenced by aggregate demand, factor prices and (R&D) investment. Research

by Aghion, Hemous and Kharroubi (2011) acknowledges that demand does impact

productivity growth, as their analysis shows that labour productivity growth declines

in the downswing of the business cycle and is higher in countries pursuing

countercyclical fiscal policies. Hence, the UN-GPM is realistically building on these

and similar insights by incorporating a Kaldor-Verdoorn mechanism to endogenize

productivity growth (see McCombie et al.; Storm and Naastepad 2014 for evidence on

the Kaldor-Verdoorn relation).

(f) a comparatively very strong empirical grounding in a consistent time-series database

and rigorous econometric estimation of the model parameters. Unlike computable

general equilibrium (CGE) models, such as the GTAP models, which “calibrate” most

of their model parameters (where calibration basically means choosing numbers which

39

serve the modeler’s purpose), the UN-GPM model parameters are mostly

econometrically estimated.

UN-GPM simulations point to substantial global welfare gains from global macroeconomic

policy cooperation—creating developmental space for the EDEs—whereas NCM models

generally suggest that the benefits from monetary policy coordination are too small and

uncertain to warrant any collaboration, while fiscal policy activism should not even be

contemplated. Clearly, the UN-GPM is the only ‘official’ policy model capable of realistically

analyzing the benefits and costs of developmental macro policies for the EDEs and the

potential benefits this would bestow on the developed countries.

Challenges

Just like any other (global policy) model, the UN-GPM has certain limitations, or, as a

Buddhist proverb has it: “a beautiful thing is never perfect.” These limitations, or model-

building challenges, have to be put in their proper context however. As I have argued above,

mainstream models (e.g. the DSGE models built by IMF economists) define away any need

for macroeconomic policy (coordination) by assuming a NAIRU-based equilibrium, price-

clearing markets and perfect foresight—which in Solow’s (2008, p. 244) words amounts to

“dumb and dumber macroeconomics”. Clearly, in terms of its macroeconomic logic and

structure, econometric basis and policy relevance, the UN-GPM bears a very favourable

comparison with benchmark mainstream models. Nevertheless, the UN-GPM has come under

critique, most notably in a piece by Bauer and Erixon (2015), who work for a free-trade think-

thank in Brussels which obtains its core funding from the Free Enterprise Foundation in

Sweden; just for the record: the Free Enterprise Foundation aims to “further and continue the

development of ideas and the open public debate based on the values of market economics,

the right to own, and free enterprise.” Writing from this partisan perspective, Bauer and

Erixon (2015) criticize the UN-GPM for allowing aggregate demand (and distribution) to

have macroeconomic impacts not just in the short run, but also in the long run. Their critique

is obviously outdated: prominent mainstream economists such as Aghion, Hemous and

Kharroubi (2011), Blanchard and Leigh (2013) and Fatás and Summers (2015) as well as the

IMF itself accept the fact that fiscal policy (and demand) does have permanent effects. Marc

Lavoie (2015) provides a convincing refutation of the misguided Bauer-Erixon critique

(which I fully endorse).

40

The critique is not à propos in one further respect, namely it fails to acknowledge the

fact that the UN-GPM has an elaborate and fundamental supply-side structure as well. I did

already mention that the model features endogenous labour productivity growth, but more

relevant here is the fact that UN-GPM is not just a demand-determined model, but a model in

which demand growth may run into capacity constraints, which in turn may trigger (cost-

push) inflationary dynamics, thereby inducing interest rate hikes and constraining the growth

acceleration (as detailed by Capaldo 2015). I do think that the supply-side specification of the

UN-GPM deserves more publicity in order to prevent misguided critiques of the Bauer-Erixon

type in the future. What is needed specifically are more detailed analyses of the various

scenarios in which any trade-offs or conflicts between policy objectives, arising from supply-

side capacity constraints, are made explicit in order to help the policy-making process. To

illustrate this point, consider the following three trade-offs associated with scenario A (“full

global coordination”):

• the acceleration in economic growth during 2013-2030 leads to sharp increases in food and energy demand—raising food and energy prices. Higher food and energy prices reduce wage growth in real terms and dampen consumption growth; because they fuel (cost-push) inflation, central banks raise interest rates, which lowers investment growth (ceteris paribus).

• higher long-term growth in scenario A brings down unemployment in developed economies, which in turn puts upward pressure on wages and hence on inflation (the UN-GPM features a Phillips-curve relationship); this will motivate central banks to raise interest rates even more.

• the faster GDP growth (probably) means higher asset prices and larger holding gains on private wealth; while these wealth gains feed back into faster private consumption growth, they may also induce more borrowing and increase financial risks—posing new challenges for central banks.

These are all examples of policy trade-offs which are already inherent in the structure of the

UN-GPM. What needs to be done, and I consider this to be the biggest challenge for the UN-

GPM, is to make it more clear to the public and policymaking community which are the

major trade-offs involved in a particular scenario and how scenario-analyses using the UN-

GPM can help to rationally navigate these trade-offs. This will not just prevent unwarranted

criticism, but more importantly enhance the usefulness and credibility of the UN-GPM.

Threats

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I can see two main threats to the UN-GPM as the main model used to assess the pros and cons

of global policy coordination. The first threat is the monopolization of macroeconomic

analysis by mainstream modelers in general and the attempt by IMF economists to

appropriate a central coordinating role in global macro policymaking for the Fund itself

(Ostry and Ghosh 2015), more specifically. Mainstream approaches, as this paper has argued,

are incapable of a realistic assessment of the benefits of global policy coordination,

unwarrantedly neglect potential long-run benefits of fiscal developmental policy, discard any

developmental role for a country’s exchange rate, and basically reduce the issue to a matter of

monetary policy coordination between the G7 central banks. The UN-GPM is the only official

model capable of exploring policy and policy cooperation in ways that support the

developmental aspirations of the EDEs.

The second potential threat is a practical one: under-funding and under-staffing.

Maintaining and further developing a global policy model implies a long-term strategic

commitment.

Opportunities

Due to the greater trade, production and financial integration between countries, the

magnitude of international (policy) spillover and spillback effects has increased to warrant

policy preparedness and international collaboration. The key rationale for such coordination

does not lie in some ‘optimal’ net welfare gain to be realized by cooperation, but in the fact

that such coordination does reduce “secondary uncertainty” and at the same time builds up

confidence around a shared vision on the world’s major policy challenges and options. That

is, coordination helps to stabilize an unstable (global) economy, because it acts as an

informational substitute for forward markets that do not exist; in a more Keynesian

interpretation, it serves the purpose of strengthening the confidence of (real economy)

investors in a reflexive manner. The UN-GPM will be an effective instrument to help bring

about such global policy coordination—because of its strengths listed above.

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Appendix

The model of Table 4 can be solved for the equilibrium real interest rates of countries 1 and 2

as follows:

2*1

*ˆ =

ΧΧ−Ζ+ΧΖ=r and

2*ˆ**ˆ =Ζ+Χ= rr

where the symbols X, X*, Z and Z* are defined as follows:

81.02

2 =ΑΕ−ΑΓ+=Χ

ϑβϑβ

,

81.0****

**2

*2 =

ΕΑ−ΓΑ+=Χ

ϑβϑβ

,

39.02

2 =ΑΕ−

ΑΒ+−=Ζϑβ

ϑβ p, and 39.0

*****

**2

*2 =

ΕΑ−ΒΑ+−=Ζ

ϑβϑβ p

This, in turn, requires the definition of A, A*, B, B*, E, E* and Γ and Γ*:

31.01 *

44

1 =−

=Αµµ

β , 31.0

1*

*44

*1 =

−=Α

µµβ

44.1*)( *14

*3431 =+−+=Β gg E µµσµµµµ , 44.1)(** 1

*43

*4

*3

*1 =+−+=Β gg E µµσµµµµ

09.032*34 =−−=Ε µµϑµµ , 09.0* *

3*23

*4 =−−=Ε µµϑµµ ,

01.0*34

*243 =−−=Γ ϑµµµµϑµ , and 01.0* 3

*42

*4

*3 =−−=Γ ϑµµµµϑµ .