The choice of monetary instrument in two interdependent economies under uncertainty

Abstract

This paper analyzes the choice of monetary instrument in a stochastic two-country setting, where each country's set of monetary policy instruments include both the money supply and the interest rate. It shows how the optimal choice of instrument is determined in two stages. First, for each pair, the minimum welfare costs for each economy is determined. This defines a pair of payoff matrices, and the second stage involves determining the Nash equilibrium for this bimatrix game. In our illustrative example, for the alternative shocks considered, a dominant Nash equilibrium is always obtained.