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Unit 20 : Forms of Economic Cooperation

a coordination of only monetary policies. This is particularly the case in the United States because Notes
fiscal policy is controlled by the Congress which, even when its majority is of the same party as the
President, may be reluctant to enact the tax changes, particularly tax increases, that a President wants.
But the reliance on monetary rather than fiscal policy will also be true in other countries because of
the greater political attention generated by changes in fiscal policy and the greater difficulty of reversing
expansionary fiscal changes if they turn out to be inappropriate.
A monetary expansion or contraction is not generally an appropriate substitute for a fiscal change.
For example, while tighter monetary policy in the United States could offset the aggregate demand
effect of large budget deficits, it would not reduce real interest rates. More generally, monetary and
fiscal policies that have equal expansionary effects at home can have opposite effects on the rest of
the world. A fiscal expansion that raises real interest rates and appreciates the currency will
unambiguously raise foreign exports and thereby stimulate the foreign economy. In contrast, a
monetary expansion that temporarily reduces real interest rates will depreciate the currency and
thereby reduce foreign exports.
The need to rely on monetary policy rather than fiscal policy is particularly a problem when the
international coordination focuses on exchange rate stabilization. If the United States had been induced
to stabilize the dollar in the early 1980s, it would have done so by increasing the money supply rather
than by cutting the budget deficit. This in turn would have increased the rate of inflation in the
United States. Moreover, although the rise in inflation and in the price level would be sufficient to
reduce the nominal value of the dollar, the real exchange rate might soon be back to the level that
would have prevailed without any change in monetary policy. A commitment to exchange rate
stabilization that leaves real exchange rates unchanged but causes higher inflation must be regarded
as counterproductive.
20.3 International Trade

Although the primary source of the unprecedented rise of the U.S. trade deficit between 1982 and
1986 was the increase in the value of the dollar and therefore indirectly the growth of the U.S. budget
deficit, the political response to the trade deficit has been an increase in attention to the specific
problems of foreign competition and international trade practices. Unfortunately, much of this response
has been a harmful backsliding from free trade to various sorts of restrictions on the flow of goods to
the United States. Recent years have witnessed the cartelization of key international markets, the
introduction of so-called voluntary restraints on a wide range of exports to the United States, and the
tightening of U.S. import quotas on textiles with the threat of much more protectionism to come as a
result of the pending trade legislation.
Of course, not all of the political response to the trade deficit has been harmful. The concern about the
U.S. trade balance has spurred a more assiduous pursuit of policies aimed at reducing foreign import
barriers, especially those of Japan and some of its East Asian neighbors. Although these policies
cannot eliminate the massive U.S. trade deficit as long as the dollar remains overvalued, they can
increase the opportunity for American firms and employees to do more in those areas where they
have a comparative advantage.
Cooperation in international trade requires not active comanagement of the economic environment
but a negotiated reduction in government interference with private flows of trade and investment.
The golden rule of international trade is the double negative injunction : “Do not unto others what
you would not have them do unto you.”
The major trade rounds of the past quarter century have been successful in achieving sharp reductions
of tariffs and quotas. But now, as several of the conference participants noted, improving the
international allocation of resources requires a reorientation of the trade negotiations.
Government subsidies to domestic industries engaged in international competition must be reduced.
This is true of agricultural policies in every major industrial country. It is also increasingly true of a
wide range of manufacturing industries in Europe as well as in many developing countries. Progress
in these areas will be difficult not only because such subsidies restrain powerful domestic political

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