After a 30-year absence, calls for international coordination of macroeconomic policy are back. This time the issues go by names like currency wars, taper tantrums, and fiscal compacts. In traditional game theory terms, the existence of spillovers may imply that countries are better off if they coordinate policies than under the Nash non-cooperative equilibrium. But what is the nature of the spillover and the coordination? The paper interprets recent macroeconomic history in terms of four possible frameworks for proposals to coordinate fiscal policy or monetary policy: the locomotive game, the discipline game, the competitive depreciation game (currency wars) and the competitive appreciation game. [The paper also considers claims that monetary coordination has been made necessary by the zero lower bound among advanced countries or financial imperfections among emerging markets.] Perceptions of the sign of spillovers and proposals for the direction of coordination vary widely. The existence of different models and different domestic interests may be as important as the difference between cooperative and non-cooperative equilibria. In some cases complaints about foreigners’ actions and calls for cooperation may obscure the need to settle disagreements domestically.

The paper reviews an event of 30 years ago from the perspective of today:  a successful G-5 initiative to reverse what had been a dangerously overvalued dollar.  The “Plaza Accord” is best viewed not as the precise product of the meeting on September 22, 1985, but as shorthand for a historic change in US policy that began when James Baker became Treasury Secretary in January of that year.  The change had the desired effect, bringing down the dollar and reducing the trade deficit.  In recent years concerted foreign exchange intervention, of the sort undertaken by the G-7 in 1985 and periodically over the subsequent decade, has died out.   Indeed the G-7 in 2013, fearing “currency manipulation,” specifically agreed to refrain from intervention in a sort of “anti-Plaza accord.”  But the day will come when coordinated foreign exchange intervention is again appropriate.

     Mauritius is a top performer among African countries. It developed a manufacturing sector soon after independence and has managed to respond well to new external shocks. What explains this success? This paper draws on the history of the island, the writings of foreign economists, the ideas of locals, and the results of econometric tests. Mauritius has mostly followed good policies. They include: creating a well-managed Export Processing Zone, conducting diplomacy regarding trade preferences, spending on education, avoiding currency overvaluation, and facilitating business. The good policies can in turn be traced back to good institutions. They include: forswearing an army, protecting property rights (particularly non-expropriation of sugar plantations), and creating a parliamentary structure with comprehensive participation (in the form of representation for rural districts and ethnic minorities, the “best loser system,” ever-changing coalition governments, and cabinet power-sharing). But from where did the good institutions come? They were chosen around the time of independence in 1968. Why in Mauritius and not elsewhere? Luck?

     Some fundamental geographic and historical determinants of trade and rule of law help explain why average income is lower in Africa than elsewhere, and trade and rule of law help explain performance within Africa just as they do worldwide. Despite these two econometric findings, the more fundamental determinants are not much help in explaining relative performance within Africa. Fundamental determinants that work worldwide but not within Africa are remoteness, tropics, size and fragmentation. (Access to the sea is the one fundamental geographic determinant of trade and income that is always important.) A case in point is the high level of ethnic diversity in Mauritius, which in many places would make for dysfunctional politics. Here, however, it brings cosmopolitan benefits. The institutions manage to balance the ethnic groups; none is excluded from the system. It is intriguing that the three African countries with the highest governance rankings (Mauritius, Seychelles and Cape Verde) are all islands that had no indigenous population. It helps that everyone came from somewhere else.

In the past, industrial countries have tended to pursue countercyclical or, at worst, a-cyclical fiscal policies in sharp contrast to emerging and developing countries that have followed procyclical fiscal policy, thus exacerbating the underlying business cycle. We show that, over the last decade, about a third of the developing world has been able to escape the procyclicality trap and actually become countercyclical. We trace this critical shift in fiscal policy to the quality of institutions. We provide a formal analysis, which controls for the endogeneity of institutions and other determinants of fiscal procyclicality, that strongly suggests that there is a causal link running from stronger institutions to less procyclical or countercyclical fiscal policy.

     Historically, many countries have suffered a pattern of procyclical fiscal policy: spending too much in booms and then forced to cut back in recessions. This problem has especially plagued Latin American commodity exporters. Since 2000, fiscal policy in Chile has been governed by a structural budget rule that has succeeded in implementing countercyclical fiscal policy. Official estimates of trend output and the 10-year price of copper – which are key to the decomposition of the budget into structural versus cyclical components – are made by expert panels and thus insulated from the political process. Chile’s fiscal institutions hold useful lessons everywhere, but especially in other commodity exporting countries.

     This paper finds statistical support for a series of hypotheses regarding forecasts by official agencies that have responsibility for formulating the budget. 1) Official forecasts of budgets and GDP in a 33-country sample are overly optimistic on average. 2 )The bias is stronger at longer horizons 3) The bias is greater among European governments that are politically subject to the budget rules.  4) The bias is greater in booms. 5) In most countries, the real growth rate is the key macroeconomic input for budget forecasting. 6) In Chile it this the real price of copper. 7) Chile has avoided the problem of overly optimistic official forecasts. The conclusion: official forecasts tend to be overly optimistic, if not insulated from politics, and the problem can be worse when the government is formally subject to budget rules. The key innovation that has allowed Chile to achieve countercyclical fiscal policy in general, and to run surpluses in booms in particular, is not just a structural budget rule in itself, but a regime that entrusts to independent expert panels responsibility for estimating long-run trends in copper prices and GDP. 

This note attempts a concise yet comprehensive overview of the crisis still facing the eurozone, in the areas of competitiveness, fiscal policy, and banking.  The euro’s founding documents enshrined such principles as fiscal constraints, the “no bailout clause,” and assignment to the ECB of the goal of low inflation to the exclusion of monetizing national debts.  Those principles have been permanently compromised.  On the one hand, German taxpayers cannot be expected to agree to bailouts of profligate euro members without end.  On the other hand, if they were to insist on those founding principles, the euro would not survive.  It is especially important to recognize that the (predictable) impact of fiscal austerity has been to reduce output in the periphery countries, not raise it, and thereby to raise debt/GDP ratios, not lower them.   The leaders have finally taken some steps in the right direction over the last year:  movement toward a banking union; more adjustment time for Greece, Portugal and Spain; and ECB bond purchases.  But much adjustment still lies ahead: more debt-reduction (painful for the creditor North) and more internal devaluation (even more painful for the uncompetitive South).  The eurozone will endure, but through a lost decade of growth.  As to a long-run fiscal regime that addresses the now-exacerbated problem of moral hazard, the Fiscal Compact is not enough in itself.   Two innovations favored by the author are the red-bonds/blue-bonds proposal and the delegation of forecasting to independent fiscal agencies.