Coordinating to Stabilize: A Model of Monetary Policy Coordination with Reputation Spillovers

MERCOSUR, a proposal for regional integration, aims also at the coordination of monetary policies. Highly unstable, poorly integrated, and with the dominant presence of Brazil, these countries are an unlikely case for coordination in the traditional sense. Can countries coordinate monetary policy, even when the benefits usually mentioned for so doing are not present? In this paper it is shown that even in time consistent equilibria, coordination of monetary policy can arise as a time consistent policy when it provides a signal to the private sector about the policymaker's type. It is shown that in that case coordination and inflation stabilization go hand to hand. This need for extra commitment in order to lower inflation is what makes the model appealing for the case of the southern cone countries. However, we show that bad history in inflation control, policy instability, and low levels of interdependence, main characteristics of the region, make it harder to achieve this kind of coordination.