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Transcript
Economic Modelling Lecture 19 Policy Game in the Global Economy 1 Growing Together or Growing Apart? East and West? North and South? Source: Phillip’s Atlas of the World 2 Two Economy Inter-dependent Global Economy Model Economy 1 Y1 C1 I1 G1 X1 M1 M1 m1Y1 X1 k1Y2 Economy 2 Y2 C2 I 2 G2 X 2 M 2 X 2 k2Y1 M 2 m2Y2 C1 I1 G1 1 m2 k1 C2 I 2 G2 Y1 1 m1 1 m2 k1k2 1 m1 1 m2 k1k2 What is Y2 ? 3 Cooperation or non-Cooperation? ............................... Developing Advanced Countries Countries NC C NC C 4,4 6,3 3,6 5,5 Nash Solution is non-cooperation (NC,NC) =(4,4) ............................... Developing Advanced Countries Countries NC C NC C 4, 4 6,3 3, 6 5,5 Cooperative Solution (C,C) =(5,5) Cooperative solution Pareto dominated Non-cooperative solution. Pareto efficiency: at least one party gains without hurting the other. 4 Extensive Form of International Cooperation Game NC NC (4,4) Advanced economies C (6,3) (3,6) Developing Economies NC C Advanced economies C (5,5) 5 Dynamics of International Policy Cooperation Game: Solution by Backward Induction NC NC (4,4) Advanced economies C (6,3) (3,6) Developing Economies NC C Advanced economies C (5,5) 6 Credibility Problem, Cheating and Discount Factor of the Game Both gain by playing (C,C) But this solution is not credible. There is incentive to deviate. Trigger Strategy Game returns to Nash path in absence of credibility. If the game is played infinite number of times the optimal discount value ff the game is calculated as PV (C , C ) 5 5 5 2 5 3 ... 5 n PV (C , C ) 5 5 5 2 5 3 ... 5 n Lim n 5 1 5 1 PV (cheat ) 6 4 4 2 4 3 ... 4 n 7 Solution for the Discount Factor of the Game PV (C , C ) 5 5 5 2 5 3 ... 5 n Lim n 5 1 PV (cheat ) 6 4 4 2 4 3 ... 4 n PV (cheat ) 6 4 2 4 3 ... 4 n1 1 PV (cheat ) 6 6 4 PV (cheat ) 6 4 lim n 1 5 6 4 1 1 5 61 4 n1 0 6 5 2 1 2 8 Internal and External Stability in an Open Economy S K Inflow K Inflow i=i* K outflow K outflow Unemployment Deflation X-M=0 Inflation Boom 0 Yn output 9 Macroeconomic Equilibrium in a Small Open Economy with Perfect Capital Mobility S IS LM i>i* BOP+ K inflow BOP+ Boom K-inflow Deflation BOP: X-M =-KA i=i* BOP- Outflow Boom/inflation Over full employment BOPK-outflow Deflation i<i* Under full employment. Yf 10 A Small Open Economy with Perfect Capital Mobility: Convergence towards A Macroeconomic Equilibrium S IS LM EXSG i>i* BOP+ BOP+ EXDM EXSG EXDG EXSM EXDM BOP: X-M =-KA i=i* BOPEXSG EXDM BOP- i<i* EXDG ESM EXDG EXDM Yf Notes: YF full employment output, BOP = Balance of Payment, K= capital, ESG =Excess supply of goods, EDG =Excess demand for goods, ESM =excess supply of money, EDM=excess demand for money 11 Interdependent Global Economy: IS-LM-BP Model IS1 LM1’ 2 1 i LM2’ LM2 LM1 IS1’ 4 6 5 i 3 1 IS2’ IS2 y1 Country 1 adopts expansionary fiscal policy output and interest rates, imports and reserves of foreign currency rise in Country 2 can export more to country 1 but looses some foreign country 1. assets, money supply decreases, and demand decreases and may have contractionary impact if its increase in exports are less than it lose of reserves. y2 12 Policy Spill-over Effects in Interdependent Economies Answer: Use a two country Mundell-Fleming Model Expansionary fiscal policy in country 1 Impact in country 2 i2=i2* i1=i1* BOP LM2’ LM2 LM1 LM2 IS2 IS2’ IS1’ O y0 IS1 y1 y2 In fixed exchange rate with perfect capital o Y mobility: g 0 y0 y2 y1 ; Y * 0 g R ; g 0 R * ; g 0 13 International Economic Policy Coordination • Gold-Standard: Automatic Adjustment Mechanism • Bretton Woods-Dollar standards • Break down of the Bretton Woods: Exchange rate crises • Plaza and Lauvre Accords and G7 Meetings • EU Growth and Stability Pact • Basel agreement of central banks, EMU, AMU, ECOWAS • IMF/ WB: Seal of approval - Paris Club • GATT-WTO-NAFTA-APEC-ASEAN-GCC • What are right models for Co-operation or 14 Interdependent Global Economy: An Example Blanchard (19.5) C 10 0.8Y T ; I 10 ; G 10 ; T 10 ; M 0.3Y ; X 0.3Y * Y C I G X M 10 0.8Y T I G 0.3Y * 0.3Y Y 0.5Y 10 0.810 I G 0.3Y * => Y 44 0.6Y * Multipliers: 1 Open Economy: 1 0.8 0.3 2 Closed economy: 1 5 1 0 .8 1 Interdependent Economy: 1 0.8 0.30.6 0.3 3.125 44 * * Y 110 Y 44 0.6Y ; => Y 0.6Y 44 => 0.4 15 Policy Spill-over Effect -1 Suppose target income at home is Y =125. Foreign income then Y 44 0.6125 119 The government expenditure to achieve target income given this foreign income * Y 0.5Y 10 0.810 I G 0.3Y => * Y 24 2G 0.6Y * ; Y 24 2G 0.6119 => G= 14.8 Net export at home NX 0.3119 0.3125 1.8 ; Government budget deficit at home: T G 10 14.8 4.8 * * Budget deficit abroad T G 0 ; and Foreign country’s net export: NX 0.3119 0.3125 1.8 =>foreign country benefits by doing nothing. 16 Policy Spill-over Effect If both countries like to achieve 125 level of target output; the common increase in G necessary to achieve this target output can be found as: Y Y * 125 ; Y 24 2G 0.6125 => 2G 125 75 24 26 => G 13 NX NX 0 ; * T G T * G * 3 17 Autarky: Saving, Capital Accumulation and Growth (Gartner (2003:262) has similar example) Country A Country B YA K A0.5 L0A.5 A 0.1 YB K B0.5 L0B.5 s A 0.2 sB 0 What is the capital stock in the steady state in A in Autarky? How much do workers get? How much do owners of capital get? sK A0.5 L0A.5 A K A 0.2 K A0.5 10 0.1K A K A 400 B 0.1 What is the capital stock in the steady state in B in Autarky? How much do workers get? How much do owners of capital get? 0.0 K B0.5 10 0.1K B K B 0 YB 0 Becomes a beggar country. YA 200 18 Impacts of Globalisation in Output and Income What is the capital stock in the steady state in A and B if there is a free mobility of capital? Country A Country B K A KB K K A KB K Country A saves for both countries. It receives rental income from country B. Country B does not save but can borrow capital from country A. 0.2 10K 0.5 0.5 10K 0.5 0.1K K K 15 225 YB K 0.5 L0B.5 2250.5 10 150 2 YA K 0.5 L0A.5 2250.5 10 150 GNP in country B = GDP+Investment Receipts GNPA = 150+75 = 225 Capitalists gain and workers lose in country A. Country B need to pay capital income to Country A. GNP in country B = GDPInvestment Payments GNPB = 150-75 = 75 Country B gains from the capital transfers. 19 Growth rate of money supply in foreign country International Monetary Policy Co-ordination GAME :Hammada Diagram (Romp p.175) R: domestic reaction B IC* IC C R*: foreign reaction B* gmN* N 450 B: Domestic bliss B*: Foreign bliss C: Pareto optimal N: Nash Equilibrium gmN Growth rate of money supply in home country 20 Optimal Tariff Game: Johnson (1954) Nash equilibrium is not Pareto Optima as the indifference curves cross each but are not tangential. t* N A* I1* R* I2* I3 A I2 t R I3* I1 21 Optimal Tariff Game: Johnson (1954) Nash equilibrium is not Pareto Optimal as the indifference curves cross each other but are not tangential. t* EE line shows all Pareto Efficient poin N A* E I1* R* I2* I3 A I2 t R I3* I1 E 22 References Blanchard (2003) Macroeconomics, Prentice Hall. Bhattarai (2001) Welfare Gains to UK from a Global Free Trade, the European Research Studies, Vol. IV, Issue 3-4, 2001. • Binmore Ken (1999) Applying Game Theory of Automated Negotiation, Netnomics,1999, v.1, iss.1 pp.1-9. • Canzoneri M. B. and J A Gray (1985) “Monetary Policy Games and the Consequences of NonCooperative Behaviour”, International Economic Review, 26:3:1985, pp. 547-567. • Benigno, Pierpaolo (2002) A Simple Approach to International Monetary Policy Coordination; Journal of International Economics, June 2002, v. 57, iss. 1, pp. 177-96 • Johnson H. G.(1953-54) Optimal tariffs and Retaliation, Review of Economic Studies, 21(2), pp.142-43. • Harrison, G.W., T.F.Rutherford and D.G. Tarr (1997) “Quantifying the Uruaguy Round”, Economic Journal vol. 107 no. 444, September, pp.1405-1430, • Binmore Ken (1999) Applying Game Theory of Automated Negotiation, Netnomics,1999, v.1, iss.1 pp.1-9. Hamada K (1976) Strategic Analysis of Monetary Interdependence, Journal of Political Economy, 84 August. Ranis Gustav and L. Raut (1999) ed. Trade Growth and Development, North Holland. Shoven, J. B. and J.Whalley (1984) “Applied General-Equilibrium Models of Taxation and International Trade: An Introduction and Survey”, Journal of Economic Literature, vol. XXII, Sept,1984, pp.1007-1051. Whalley John (1985) Trade Liberalisation Among Major Trading Areas, The MIT Press. Williamson J. and M. Miller (1987) Targets and indicators: a blue print for international coordination of economic policies, Institute of International Economics, Washington. • • • • • 23 Should Policy be Active or Passive? Classical Economists on Economic Policy Economy left itself will do better than with an active intervention. Perfectly flexible prices of goods, labour and capital guarantee full employment equilibrium consistent with maximisation of welfare. Supply creates its own demand in a free market economy (general equilibrium model as we discussed in micro foundation part describe the frictionless economy). Classical economists believed that active policy may do more harm than good. 24 Lags in Economic Policy Recognition lag: turning points of business cycle difficult to recognise Decision lag: parliamentary process, dispute among political parties Implementation lag: It takes time for policy to reach to grassroot level Impact lag: institutional and technological inertial and persistent habits 25 Classical, Keynesian and Monetarist Approaches to Economic Policy Classical economists suggest “do-nothing” or “do minimum” policy to be better than an active policy. - Well-intentioned policy makers do more harm than good. - The self interest of the policy makers may not be in the best interest of the country. - Money is neutral. Monetarist argue for a money supply rule such as the interest rate rule Keynesian favour active policy New-classical like classical argue for minimum role of the government 26