Games and Politics: An Examination of Persistent U.S. – China Financial Imbalances

The fact that the U.S. and China have maintained large and persistent financial imbalances is not under dispute. There is disagreement about whether or not these imbalances can be sustained. Within this discussion, much of the literature focuses on the corrective policies required by the U.S. and/or China to eliminate these imbalances, if one considers correction necessary. This paper argues that the appropriate way to model the correction decision for both the U.S. and China is to use a game-theoretic approach. An example is then provided that illustrates how a game-theoretic model can be used to determine the equilibrium policy choices by the U.S. and China under two different assumptions: that the imbalances are sustainable and also under the assumption that the imbalances are unsustainable. Lastly, it is argued that only by utilizing a political economy model, can the choice of policy actions with each country be fully examined, as the policies are undertaken under political constraints in each country.