Second, since binding agreements are unenforceable, the aspiring cartel must design its pricing policy in such a way that it remains in everyone's self-interest to stick to the agreement. This is a difficult task because aggregate shocks alter the costs and benefits of cheating, and unless the cartel's pricing policy recognizes these changing incentives, it may not be sustainable. For example, Rotemberg and Saloner argue that positive demand shocks increase the temptation to cheat on a collusive pricing agreement, since a cheater who undercuts his co-conspirators would get to supply the market when demand and profits are high. Of course, eventually the cheater is detected, but only after demand and profits have declined to more normal levels. To prevent this from happening, which would trigger a breakdown of cooperation, the cartel must actually lower prices when demand is high.
Lower prices reduce the incentive to cheat on the agreement.
They do not reflect a breakdown of cooperation. Interestingly, Rotemberg and Saloner provide empirical evidence that most price wars have occurred during periods of strong demand. Like a cartel attempting to sustain collusion, central banks in Southeast Asia were attempting to fix their exchange rates to the dollar in order to avoid mutually destructive competitive devaluations. That is, if left to itself, each central bank would like to respond to falling export demand by devaluing its currency. If this incentive is strong enough, the only way for central banks to prevent a total collapse of cooperation is if all countries devalue together.