Ever since the breakdown of the Bretton Woods System, there has been a chorus of economists calling for internationally negotiated coordination of macroeconomic policies. Most of them work for international organisations or have developed a special interest in discretionary macro-policy or optimal-control theory.

At the same time, very little centralised coordination has actually taken place. Exchange rate surveillance by the International Monetary Fund does not seem to have played a major role. The economic summit meetings are not used to coordinate macro-policy any longer. Even the first Bonn Summit (1978), the apparent showpiece of centralised coordination, does not seem to have yielded internationally negotiated macroeconomic policy concessions from national governments, but rather enabled their leaders to pursue their domestic objectives against strong internal opposition.

In this paper we use a two-country model of flexible exchange rates to analyse strategic interdependence. Values for the policy instruments are selected from discrete sets, increasing the likelihood of a non-unique Nash equilibrium. Communication between the policy makers becomes very important; we define international institutions as communication devices, since their mission in the context of our model (we are in a one-shot game) is indeed the exchange of some information, either policy proposals or recommendations. We discuss two such devices: direct communication (for instance, a telephone line), and communication through a mediator (an international parliament) that makes policy recommendations to both countries, which are not necessarily followed. The conclusion is that these devices may increase actual or expected welfare levels and ease agreement between decision makers, even in a world where Nash equilibria are efficient.

Recently, in most of the economically advanced European countries inflation has been substantially reduced. But that went together with a rise in the rate of unemployment to levels not experienced for the last 30 years. Forecasts predict that unemployment is unlikely to decrease within the coming years. The increased interdependence of national economies led to calls for coordinated policy actions in order to expand economic activity in Europe, thus avoiding costly non-cooperative strategies.

There is, however, a strong criticism of proposals for coordination of national stabilisation policies. Economic theory, it is said, proves that such a coordination is at best superfluous and may even be harmful. An eloquent exponent of this view is Vaubel (1985).

This view is the result of assuming that there is no need for macropolicy on a national level in the first place. The present paper intends to show that this cannot be justified on purely theoretical grounds. It will be argued that this assumption does not follow from sound theoretical arguments.

Unemployment has risen steadily during the last five years in all of the major European economies. Although there have been some signs that the rate of increase may have slackened this is mainly due to the fiscal-led expansion in the United States. Recent evidence suggests that the growth rate in the United States is slackening, and the need to reduce the structural budget deficit means that the rest of the developed countries can no longer rely on the United States as the main source of demand growth in the world economy. In spite of this, European governments have been reluctant to undertake fiscal and monetary policy actions which might sustain the recovery. In part this reflects a pessimism about the efficacy of conventional stabilisation policies born of the experience of the mid-seventies. However, the current situation is arguably very different now. Whereas the recession of the mid-seventies was largely the result of a supply-side shock requiring a downward adjustment in real wages, the recession of the early eighties is largely a consequence of the contractionary fiscal and monetary policies pursued outside the United States. That the present high levels of unemployment are Keynesian rather than Classical in nature has been argued forcefully by e.g. Dornbusch et al. (1983) and Bruno (1985). A reversal of these contractionary policies could therefore be expected to increase employment. Thus Layard et al. (1984) have argued there is scope for a temporary, supply-side friendly, fiscal expansion concentrated in public investment, subsidies to private investment and measures to reduce the marginal cost of employment. This would be accompanied by a modest relaxation of monetary policy to prevent real interest rates rising. Because such an expansion would be temporary it need have no long-run implications for inflation or real interest rates.

Coordination of economic policies and convergence of economic performance within the European Community are objectives already laid out in the Treaty of Rome. A number of later decisions by the Council of Ministers reaffirm and specify these principles. The 1974 Convergence Decision provides a procedural framework for review of the economic situation and policy with the aim of bringing about greater convergence of macroeconomic performance. In this process a central place is given to the setting of budgetary policy guidelines. In addition, the EMS provides a potentially strong mechanism for coordinating monetary policy under the constraint of fixed, but adjustable, exchange rates and, in principle, free capital movements.

According to the European Community Commission the present level of unemployment in Europe should not only last but worsen in the foreseeable future (see CCE 1984). By 1988 the overall unemployment rate in Europe should reach 11,4% if the « optimistic » assumptions retained for the labor supply are to be realized.

These are of course average figures but on the whole they correctly reflect the extraordinary convergence of European deflationary policies. Given structural differences, which remain very limited when one compares them to the other Western economies, the European governments seem to have settled for the same macroeconomic strategies. Of course, they have chosen different timings. France, for example, has grown more than its partners in 1981-1982 but is now experiencing a prolonged recession. Whereas West Germany is doing better as far as GNP is concerned but grew very little in the early 80 s. On the whole however a back of the envelope calculation of « sacrifice ratios » for the leading European economies would yield quite similar results. All over Europe disinflation has been achieved at a high output cost and it is not clear that any country has really done better than its partners.

The small open economies of the Nordic type (Sweden, Norway and Finland, in particular) have close similarities as far as their economic structure and institutions are concerned. They are all heavily dependent on foreign trade; their exports are quite highly concentrated and cyclically sensitive; the labour market partners are well organized and the wage-setting institutions are fairly similar; economic policy priorities are also rather close to one another, with heavy emphasis on employment, growth and external balance.

Against this background of structural similarities, one cannot help but notice that there are clear systematic and persistent differences in the economic policy mixes adopted by these countries. Notwithstanding the fact that these differences are partly explained by different political coalitions, different traditions of economic policy thinking etc, it is worth analyzing the contents of these differences as such and assessing their effects on the economic performance of different Nordic countries. This is what the present paper attempts to do from a certain restricted perspective. In particular, it highlights the peculiarities of the Finnish policy mix.

The high inflation rate and the increase in the unemployment rate coupled with very low growth rates, occured as a result of the second oil crisis, was confronted the policy makers of the new administration with a dilemma. They responded with a compromise of different sorts of policies aiming at achieving a gradual reduction of the inflation and unemployment rates so that they are reduced down to equilibrium over a long enough period of time.

However, the monetary and fiscal policies adopted are not considered as a single macroeconomic instrument. The growth of real output is pursued with an expansionary public and fiscal policy, while inflation is confronted with restrained monetary policy against the private sector of the economy. Moreover, the way prices and incomes policy is adopted postpones recovering of output and profits, thus creating serious fears for a further increase of unemployment and a resurgence of inflation.

In a series of papers (Ginsburgh and Erlich (1984), Ginsburgh and Van der Heyden (1985), Erlich, Ginsburgh and Van der Heyden (1985)), we have tried to assess by how much the real wage should be or should have been decreased in order to ensure short and/or long run full employment.

This short note describes the main ideas lying behind the general equilibrium model built to answer these questions and summarizes the main results.

The model attempts to embed a situation of short run market imperfections into a long run competitive equilibrium framework. If price rigidities and a lack of substitution between factors are acceptable assumptions in the short run, there do exist no better concepts than flexible prices, substitution possibilities and equilibrium in all markets in the long run.

In most macroeconomic models, variations in nominal variables, such as inflation or money growth, are considered to be important determinants of cyclical fluctuations in real activity. The major hypothesis in that respect is the so-called Phillips-curve. In its modern interpretation, it maintains that only unexpected changes in nominal magnitudes produce real effects. Reliable empirical evidence on these effects is therefore crucial for the building of macroeconomic models and the conduct of monetary policy.

Time series of output, industrial production or employment however contain growth and seasonal components in addition to cyclical elements. The empirical implementation of business cycle models therefore requires assumptions with respect to growth and seasonal parts as well, in order to isolate cyclical movements and to avoid misspecified equations. It has become general practice to assume that economic growth can be reasonably well approximated by a deterministic linear time trend. Seasonality is either captured through the explicit introduction of dummy variables or the use of seasonally adjusted data. Again, these procedures assume a deterministic seasonal structure. It is generally concluded in this literature, that unanticipated and possibly also expected changes in nominal magnitudes have non-negligible real effects.