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Fiscal Policy Coordination and International Trade

While assertions are often made that non-cooperative fiscal policies suffer a contractionary bias, general equilibrium models have shown that the bias is unambiguously expansionary. This paper argues that the latter result relies on a particular and critical way of modelling international trade, and that under a more plausible trade structure, it is possible that fiscal policy is insufficiently expansionary in the non-cooperative case. Non-cooperative policy-making thus implies that fiscal policies are used too little if they expand private employment, and too much if they contract private employment. Inefficiencies in non-cooperative fiscal policies worsen when product markets become more integrated.