Introduction

Although most of the literature on macroeconomic policy design has focused on policy questions in the single open economy, there is an important strand that is concerned with the issues raised by interdependence between economies (see, for example, Hamada and Sakurai, 1978; Hamada, 1979; Canzoneri and Gray, 1983; Cooper, 1985; Corden, 1983; Miller and Salmon, 1985a, 1985b; Sachs, 1983; and Turner, 1983, 1984). This literature emphasises the game-theoretic, strategic aspect of policy-making in the international arena, and the prospect that non-cooperative forms of policy, arising from the elements of externality in the effects of policy internationally, may lead to outcomes markedly inferior to those of cooperative policies.

As Corden (1983) notes, analytical tractability has limited this analysis to static models, or to dynamic models with rather rudimentary dynamics, or to the neglect of the longer-run dynamics by focusing only on short-run outcomes. In view of the complexities of the interactions between countries, whether through prices, real demands, asset prices or the flow of funds, this neglect of dynamics is a clear limitation. In this chapter, we seek to overcome it by examining policy interactions and interdependence in a stochastic rational expectations model with developed dynamics within a framework that considers both the short- and longer-run effects of policy.

In the arena of policy debate, there has been evident the objective of formulating policy in terms of simple rules.