Fiscal Policy Coordination and International Trade

While assertions are often made that non‐cooperative fiscal policies suffer a contractionary bias, general equilibrium models have shown that the bias is unambiguously expansionary. This paper argues that the latter result relies on a particular and critical way of modelling international trade, and that under a more plausible trade structure, it is possible that fiscal policy is insufficiently expansionary in the non‐cooperative case. Non‐cooperative policy‐making thus implies that fiscal policies are used too little if they expand private employment, and too much if they contract private employment. Inefficiencies in non‐cooperative fiscal policies worsen when product markets become more integrated.