International Coordination of Fiscal Policy in Limiting Economies

Abstract

This paper examines the limiting behavior of cooperative and noncooperative fiscal policies as countries market power goes to zero. In the first part we provide sufficient conditions for these policies to converge. In the second part we provide examples where these policies diverge. Briefly, we show that if there are unremovable domestic distortions then there can be gains to coordination between countries even when countries have no ability to affect world prices. These results are at variance with the received wisdom in the optimal tariff literature. The key distinction is that we model explicitly the spending decisions of the government while the optimal tariff literature does not.

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