Optimal Monetary Policies and Policy Interdependence in the World Economy

Abstract

The literature on strategic policy interactions has focused on the implications of alternative strategic policy interactions, cooperative versus noncooperative, for equilibrium macroeconomic policies given the state of the world economy. This paper asks how changes in world economic conditions alter equilibrium policies given the nature of policy interdependence among nations. The paper considers a world economy comprised of two countries operating under a system of flexible exchange rates. Both governments act noncooperatively and choose the rate of growth of their money supply so as to maximize the utility of their country’s residents given the rate of growth of the other country’s money supply. The resulting Nash equilibrium rates of growth of the home and foreign money supplies are determined and the dependence of international differences in money growth and inflation rates on international differences in technology. (JEL E52, E60, F41, F42).