The Terms of Trade and the International Coordination of Fiscal Policy

Michael Devereux

Economic Inquiry, 1991, vol. 29, issue 4, 720-36

Abstract: This paper develops an example of a noncooperative game between fiscal authorities in two countries. The key strategic link between countries is the terms of trade. An equilibrium without cooperation is characterized by excessive tax rates and public spending levels in each country. The outcome is analogous to the Nash equilibrium of the static optimal tariff game in trade theory. But in this model there is also a dynamic distortion caused by noncooperative behavior. This dynamic distortion depresses capital accumulation and reduces the equilibrium capital stock in each country. Numerical examples suggest a significant welfare benefit of cooperation. Copyright 1991 by Oxford University Press.

Date: 1991
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