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In the aftermath of the Bretton-Woods agreement, the general perception was that a flexible exchange rate was a way of insulating domestic employment from foreign economic di turbances, including foreign monetary policy. Thus, there was no need for central banks to intervene in foreign exchange markets or to coordinate their monetary policies for stabilizing the economy. All thatwas needed were flexible exchange rates.

This chapter provides the mathematical material that is used throughout this book. In particular it describes the standard general framework of the differential games and the numerical algorithms that will be used in the coming chapters to solve the policy coordination problems.

This chapter presents a dynamic symmetric two-country model of a Monetary Union (MU). This model features short-term nominal rigidities, thus creating scope for active stabilization policies. To focus on the design and effects of fiscal policies in an MU, monetary policy is held fixed in this chapter. Three basic questions are focussed upon:

This chapter analyzes the effects of active monetary stabilization policy in an MU. It extends the analysis of the previous chapter, where monetary policy was held passive and the focus was entirely concentrated on (the coordination of) fiscal policies. In this chapter we will study the effects of active monetary policy andalternative regimes ofmacroeconomic policycooperation with their impact in a dynamic model of macro economic adjustment in an MU.

The recent large interest in endogenous coalition formation theory was boosted by several factors.International agreements among nations are more and more important in the globalizing economy. Examples of transnational issues range from economic cooperation, migration liberalization, technological cooperation and so on, to environmental protection. Especially studies on this last issue delivered very interesting developments in the endogenous coalition formation theory.1 The common characteristic of all these problems is that welfare of each country depends not only on its own actions but also on actions of other nations. In other words, actions of each agent induce externalities, which can (but does not have to) deliver strong incentives to cooperate. Apart from international agreements, endogenous coalition formation theory has been utilized in various other important research fields, such as R&D, creation of oligopolies, etc. Again, the common feature of all these settings are externalities from coalition formation, which make a coalitional approach relevant for players, welfare.

In Chapter 4 we analyzed monetary and fiscal policy interactions in a twocountry monetary union (MU). While this setting yields many important insights, it seems also interesting to consider an MU with a larger number of participants. This chapter, therefore, seeks to generalize the previous analysis by introducing a multi-country MU model. Moreover, we consider a more general shock structure which is based on price levels instead of (relative price) competitiveness. Furthermore more general inflation dynamics are introduced, i.e. the effects of foreign inflation rates, as suggested by the recent open economies’ literature.

In Chapter 6 the multi-country MU setting was analyzed. It was shown that many basic insights of the 2-country MU model of Chapters 3 and 4 carry over to a multi-country setting and that at the same time a multi-country MU features many new issues. These new issues were, in particular, related to the strongly increased number of interactions and economic externalities and the more complicated patterns in policy coordination due to the numerous opportunities of coalition formation. However, Chapter 6 did not address the questions why and when countries decide to participate (or not to participate) in an MU. Yet, this question seems of crucial importance in understanding the actual design and functioning of MUs.

In Chapter 7, the open MU was studied and it was analyzed how the interactions with countries that are outside the MU imply additional spillovers and coordination issues. Moreover, the possibility that countries enter the MU was investigated, resulting in a number of new interesting insights. In this chapter the analysis takes a final step by considering the setting of multiple economic and currency unions.

International macroeconomic policy coordination is an important, but complex topic. The practice of international policy coordination has not been without disappointments, fuelling the arguments of sceptics to propagate a approach instead. A approach, however, ignores that in an increasingly integrated and global world economy, there are significant positive and negative externalities. Economic externalities create the scope and scale for coordinated policies in order to outperform upon a setting with non-cooperative policies. Or putting it in a more negative manner: in case of non-cooperative policies, policymakers -purposely or not- impose with their policies externalities upon each other, since their individual policy decisions do not take account of the consequences for other policymakers. In other words a non-cooperative setting is unlikely to deliver optimal outcomes.