Gains from Policy Coordination between Taiwan and the United States — On the Games Governments Play

As we have seen in Chapters 5 and 6, the US financial conditions influence the emerging economies in Asia, often resulting in economic instability in the region. Thus, in this interdependent and competitive world, one way to prevent external disturbances is to try to coordinate fiscal and monetary policies among the countries. This chapter applies the game-theoretic method to study the nature of potential gains from international monetary policy coordination in a simple two-country model, utilizing Taiwan and the United States. We specify a Mundell–Fleming–Dornbusch type two-country model, in which one country is small and the other is large. We then analytically derive the Nash equilibrium, cooperative equilibrium, and the Stackelberg equilibrium. The second part of the chapter is a simulation study based on the theoretical model of the previous sections. Using the time-series data of Taiwan and the United States, we assume monetary policy as the control variable. We first estimate the parameter of the model through the least squares method from 1976 to 1989 for each country and then use these estimated parameters to simulate the two-country model. In the case of our two-country model, we find that policy coordination does not pay for the small country, while it is indifferent for the large country. The last section gives explanations, interpretations, and some observations.