Discuss the basic features of international policy coordination.
There may be two sources of interdependence between national economic policies, club goods and horizontal spill overs. The first has been considered to be more innovative one and is characteristic for Stage III of EMU. So as far as spill over is concerned; it is more conventional in nature. With reference to EMU, “club goods” are defined as the economic variables that are shared among all member countries.
The main club good is the basically unified, competitive market for goods, services, capital, and labour. Additional club goods, such as the price level, emerge from the fact that the member countries share a single currency, a common central bank, and a common payment system. Similarly, low currency risk, external balance and the stability of the EMU banking sector and financial markets are club goods whose benefits accrue to all member states simultaneously. The importance of these club goods can at the best be illustrated by an example. Let us start from a macroeconomic equilibrium and assume that a large number of EMU member states adopt a tax policy that leads to a slow-down in economic growth and an increase in prices, for example, increase in social security taxes. This raises the general price level in the
Euro area. The European Central Bank reacts to this change and increases its interest rate, which upsets the macro economic equilibria in the other EMU member states. Obviously, attempts to preserve the price stability would incur some cost to other members also. It clearly means that the existence of EMU club goods may act as a new channel for externalities between national economic policies.
Take another interesting case which will clarify the working of coordination mechanism better. If a member State in EMU, defaults on its public debt it will lead to capital impairment amongst its creditors, not least the commercial banking system. The risk that this banking crisis will spread to the rest of the Euro area would place the European Central Bank under intense pressure and it will come forward to bail out the defaulty member State, even if this destabilises Euro Area prices and in doing so, the central bank will ultimately loose credibility.