Policy Interdependence: Does Strategic Behaviour Pay? An Empirical Investigation Using the Liverpool World Model

Previous empirical studies have found the gains from international policy coordination to be small relative to the imprecision with which policy can be framed. This paper investigates whether there are larger gains to strategic behavior (interpreted as Nash noncooperative equilibria), as compared with "insular" strategies, in which it is assumed that other players do not react to changing circumstances. It identifies the frequent international meetings of officials as a means to strategic behavior. The paper considers three episodes: United States and European disinflation in the early 1980s, Mitterrand's "dash for growth" in 1981-2, and the timing of Mrs. Thatcher's disinflation in 1980. The Liverpool World Model, which exhibits high spillovers because of both trade and financial market linkages, is used to estimate the "strategic", "insular" and "cooperative" solutions for these episodes. The paper finds in each case that the move from insular to strategic behavior does indeed yield larger gains than the further move from strategic to cooperative behavior.