Electoral Cycles and International Policy Coordination

This paper analyzes the interaction between domestic politics and international policy coordination as a two-level repeated prisoners’ dilemma. At the domestic level, political competition generates an electoral cycle in monetary growth rates and real output. At the international level, the policy-makers’ desire to promote domestic expansion by devaluing the currency gives rise to an inflationary bias in their monetary policies. The policy-makers’ incentives to cooperate at one level are affected by the extent to which they are engaged in cooperation at the other level. It is shown that a move towards international cooperation, which reduces the inflationary bias in monetary policy, may increase the amplitude of the electoral cycle. The conditions are derived under which international cooperation has a stabilizing effect on domestic politics by strengthening the incentives of domestic policy-makers to avoid generating an electoral cycle in the first place.