Figure 11.15. International coordination of fiscal policy under real wage rigidity in both countries under a coordinated fiscal policy is:

min LG± 1(g — y)2 + i (g* rg —

tg*,g)

+ tlg2 + (g*) 2 22 ag* = (g + — + (g* + —y) + og* = o.

By comparing these first-order conditions under cooperative behaviour to the ones relevant under non-cooperative behaviour (given in equations (11.58)-(11.59)), it is clear that in the cooperative solution the policy maker explicitly takes into account the international spill-over effects that exist (represented by the terms premultiplied by and r in (11.62) and (11.63), respectively). By solving (11.62)-(11.63) for g and g* (again for the special case = .*), the spending levels under coordination are obtained:

gc = = 1+ , for = (11.64)

where the subscript "C" is used to designate cooperation.