The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
In an interconnected world, national economic policies regularly lead to large international
spillover effects, which frequently trigger calls for international policy cooperation. However,
the premise of successful cooperation is that there is a Pareto inefficiency, i.e. if there is scope
to make some nations better off without hurting others. This paper presents a first welfare
theorem for open economies that defines an efficient benchmark and spells out the conditions
that need to be violated to generate inefficiency and scope for cooperation. These are: (i)
policymakers act competitively in the international market, (ii) policymakers have sufficient
external policy instruments and (iii) international markets are free of imperfections. Our
theorem holds even if each economy suffers from a wide range of domestic market
imperfections and targeting problems. We provide examples of current account intervention,
monetary policy, fiscal policy, macroprudential policy/capital controls, and exchange rate
management and show that the resulting spillovers are Pareto efficient, as long as the three
conditions are satisfied. Furthermore, we develop general guidelines for how policy
cooperation can improve welfare when the conditions are violated.