Game of Thrones: Accommodating Monetary Policies in a Monetary Union

Dmitri Blueschke,Reinhard Neck

doi:10.3390/g9010009

Abstract

In this paper, we present an application of the dynamic tracking games framework to a monetary union. We use a small stylized nonlinear three-country macroeconomic model of a monetary union to analyze the interactions between fiscal (governments) and monetary (common central bank) policy makers, assuming different objective functions of these decision makers. Using the OPTGAME algorithm, we calculate solutions for several games: a noncooperative solution where each government and the central bank play against each other (a feedback Nash equilibrium solution), a fully-cooperative solution with all players following a joint course of action (a Pareto optimal solution) and three solutions where various coalitions (subsets of the players) play against coalitions of the other players in a noncooperative way. It turns out that the fully-cooperative solution yields the best results, the noncooperative solution fares worst and the coalition games lie in between, with a broad coalition of the fiscally more responsible countries and the central bank against the less thrifty countries coming closest to the Pareto optimum.

Highlights

The Great Recession, the financial and economic crisis of 2007–2010, was the most severe contraction of advanced economies since the Great Depression of the 1930s
We examine some key aspects of such interactions between several governments, with different preferences in the output-public debt trade-off and a common central bank, which is formally independent, but accountable to the public in the area of the monetary union
We presented an application of the dynamic tracking games framework to a monetary union

Summary

Introduction

The Great Recession, the financial and economic crisis of 2007–2010, was the most severe contraction of advanced economies since the Great Depression of the 1930s. We developed a small macroeconomic model for a monetary union with some features of the Euro Area and investigated the interaction between monetary and fiscal policy using dynamic game theory [12,13]. We examine some key aspects of such interactions between several governments, with different preferences in the output-public debt trade-off and a common central bank, which is formally independent, but accountable to the public in the area of the monetary union. We look at the collusive solution, i.e., the Pareto-optimal solution with equal weights for each player This allows us to compare the results of noncooperative policy making (each country for itself), various forms of partial cooperation and full cooperation as in a full fiscal and monetary union.

Description of the Dynamic Game Problem

The MUMOD2 Model

Results

Sensitivity Analysis

Conclusions and Outlook