Abstract
Stabilization policy is modeled as a linear-quadratic differential game between government and central bank aiming at a reduction of unemployment and inflation with different weights attached to these targets. We derive non-cooperative open-loop Nash equilibrium strategies for both players, showing them to be constant, subgame perfect (feedback Nash equilibrium strategies), and simultaneously Stackelberg equilibrium strategies with either player as the leader. For the same game, cooperative Pareto-optimal strategies are derived, also resulting in constant controls to be interpreted as fixed policy “rules”. It is shown that non-cooperative outcomes in general do not belong to Pareto-optimal ones and therefore are inefficient.
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