Economic Globalization
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With the rapid development of economic globalization, the interdependence between countries has deepened greatly. Every country will exert “spillover effects” on other countries and in the same time, influenced by “repercussion effects” while it is fulfilling its own macroeconomics targets by exercising its monetary policies. Based on our theoretical and empirical analysis, each country not only sets economic policies according to domestic welfare function alone, but also needs to take other countries policy target and responses into consideration, in the course of developing its internally and externally balanced economic goals. Therefore, it is necessarily a rational choice for countries to coordinate their economic policies.

The frequent outbreaks of international financial crisis in the 1990s showed us that the economic interaction has been strengthened without stop. An economic shock to one country will surely generate shocks to other countries by disturbing their original stability through international transmission. Without immediate and effective policy coordination, this disturbance will be expanded and deepened. Western countries have been practicing the international monetary cooperation ever since the setup of Bretton Woods System. Again, during the recent American subprime crisis, the central banks around the world have been actively coordinating the monetary policies to lessen the negative shocks of it, and thus to restore the normal and orderly growth of the world economy. In this scenario, it becomes extremely important, practical and urgent to study the monetary policy coordination under the international transmission of asymmetric shocks.

The purpose of this study is to show the conditions under which the monetary policy coordination can effectively respond to asymmetric shocks, that is, when it is effective for the monetary authorities to coordinate the monetary policies to dampen the effects of shocks. For this purpose, we explores the mechanism of the international transmission of asymmetric shocks, and adopts game theory to study the policy responses and the optimization problems, aiming to provide beneficial policy suggestions for China to participate in the coordination of international monetary policy.

There are seven sections in this paper. The main logic is to establish an analytical framework to derive policy conclusions with a theoretical model based on the analysis and evaluation of the existing research results, and then to give policy suggestions for Chinese government following an empirical study on the subprime crisis.

Asymmetric shocks refer to the shocks that cause asymmetric influences on the home country and other countries originated from a single economy. This paper builds an interdependent model of two countries by introducing the international transmission channel of shocks to the traditional AS-IS-LM model. It shows that, the asymmetric shocks will result in locomotive effects and beggar-thy-neighbor effects, depending on the channel of transmission of these shocks. According different natures of the shocks, locomotive effect (the real GDPs growth of one country can lead to another countrys GDP to grow) will happen when the aggregate demand as a channel of transmission prevailed in the international transmission for asymmetric monetary and demand shocks; while beggar-thy-neighbor effect (one countrys growth in real GDP will lead to a decline in another countrys real GDP) will happen when interest rate and exchange rate channels prevail. The effect of asymmetric supply shock is independent of the channel of the transmission. By adopting the methods of Recursive Model, our model analyzes the effects of shocks on the origin country firstly, and then traces their effects in the model of transmission country. According to this framework, we can establish an interdependent two-country model, in which both the output and the price are expressed as functions of asymmetric shocks.

Under the analysis framework, this paper study how a country responds to asymmetric shocks by choosing and exerting policies. First of all, there are two policy targets in this two-country model: price stability and production stability. These two countries might have different preferences regarding to the policy targets, and thus, the policy reaction functions would differ. Secondly, assuming two countries differ in the preference, they might face conflicts if they simultaneously maximize their own welfare, so they need to coordinate to obtain Pareto improvement. The reason is that coordination can internalize the externality produced by the shocks. Finally, there exist conditions under which the coordination cannot have predicted effects depend on cooperation desirability. Given the uncertainty and immeasurability of the benefits from policy coordination, the trend for the monetary authorities to make monetary policy might be policy adjustment. The fluctuation of monetary policy means risk for every countrys monetary authority. Only when it is properly perceived about the lower adjustment level with coordination will the authorities desire and actively pursue the international coordination.

A common assumption of the policy makers objective function is to evaluate the loss function which depends on the changes of output and price level to measure the welfare effects with/without policy coordination. Henceforth, a graph is drawn according to an analysis based on game theory to illustrate directly the welfare effects without policy coordination when countries

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Monetary Policies And Economic Shock. (July 10, 2021). Retrieved from https://www.freeessays.education/monetary-policies-and-economic-shock-essay/