Monetary Cooperation during Global Inflation Surges

In a multicountry model with nominal wage rigidities, two sectors (tradable with convex supply, nontradable with flat supply), and free capital mobility, the paper studies optimal monetary policy during a global demand reallocation shock — a shift in preferences toward tradables (ω₀ > ω). Under cooperation (Proposition 1), the optimal response allows inflation to rise: higher tradable goods prices reduce real wages (restoring labor demand), generate expenditure switching back toward nontradables, and boost nontradable employment through an income effect. Cooperation achieves full employment as long as the inflation cost is below the full-employment threshold; otherwise it strikes the optimal inflation-unemployment balance. Under noncooperation (Proposition 3), each national central bank perceives it can attract capital inflows by raising its policy rate — inflows sustain nontradable demand and reduce the domestic sacrifice ratio of disinflation. But in a symmetric Nash equilibrium, synchronized rate hikes cancel each other through global credit market clearing; only the global monetary contraction remains. The result is lower inflation than under cooperation but higher unemployment — a competitive appreciation trap that mirrors the competitive depreciation failures of the Great Depression and the 2008 crisis, but in the opposite direction (global scarcity rather than deficiency of tradables). In a numerical example calibrated to α = 0.64 (convex tradable supply, implying 0.57 price-output elasticity, from Boehm and Pandalai-Nayar 2022) and ω = 0.3 (US pre-COVID tradables share), a 3 percentage point demand reallocation (matching the US COVID episode) requires approximately 1.5 percentage points of inflation to maintain full employment under cooperation; without any inflation, unemployment rises by approximately 8 percentage points. At ω₀ = 0.35, the uncooperative equilibrium reduces inflation by approximately 1 percentage point relative to cooperation but pushes unemployment to approximately 7 percent. For the COVID-19 episode, the authors conclude gains from cooperation were likely small (full employment maintained globally); for the 1980s synchronized tightening — when central banks explicitly sacrificed employment to fight inflation — the model implies substantially positive gains, consistent with the heated cooperation debates and the 1985 Plaza Accord.

Luca Fornaro | Macro Paper Warehouse

Monetary Cooperation during Global Inflation Surges