Monetary Policy Game Research Articles

Competing Coalitions in International Monetary Policy Games

In Kohler (2002) we analyse coalition formation in monetary policy coordination games between n countries. We find that positive spillovers of the coalition formation process and the resulting free-rider problem limit the stable coalition size: since the coalition members are bound by the union's discipline, an outsider can successfully export inflation without fearing that the insiders will try to do the same. In this paper, based on the same model, we allow countries to join competing coalitions. The formation of a large currency bloc is not sustainable since it would impose too much discipline on all participants. However, the co-existence of several smaller currency blocs may be a second-best solution to the free-riding problem of monetary policy coordination.

Policy rule Nash equilibria

Abstract. We study how different types of instrument rules affect the outcome of a monetary policy game between the central bank and the private sector. Policy rules can be independent of output and a shock, functions of the shock, or functions of output. We rank the Nash equilibria generated by different types of policy rules according to the central bank's ex ante expected loss. If both players can condition on output, then the following is true: no equilibrium exists if the central bank cares much about output stability and little about price stability, and infinitely many equilibria exist otherwise. JEL classification: E52, E61Equilibres à la Nash des règles de politique. L’auteur étudie comment le choix de divers types de règles instrumentales a un effet sur le résultat d’un jeu de politique monétaire entre la banque centrale et le secteur privé. Les règles de politique peuvent être indépendantes de la production ou d’un choc, être fonction d’un choc ou de la production. On établit un ordre des équilibres à la Nash engendrés par ces divers types de règles de politique selon la taille des pertes anticipées ex ante par la banque centrale. Si les deux joueurs fondent leur comportement sur la production, il s’ensuit que — aucun équilibre n’existe si la banque centrale est très préoccupée par la stabilité du niveau de production et peu préoccupée de la stabilité des prix, et autrement, une infinité d’équilibres existent.

Monetary and Fiscal Policy Games and Effects of Institutional Differences between the European Union and the Rest of the World

<titre>R&#233;sum&#233;</titre> Les interactions strat&#233;giques entre les autorit&#233;s budg&#233;taires et mon&#233;taires sont &#233;tudi&#233;es dans un mod&#232;le &#224; trois pays. La comparaison des &#233;quilibres non coop&#233;ratifs montre que la solution de Stackelberg avec leadership budg&#233;taire peut &#234;tre analys&#233;e comme un m&#233;canisme de coordination de second rang. La coop&#233;ration intra-zone procure les gains de bien-&#234;tre les plus importants. &#192; l&#8217;inverse, la coordination internationale des seules politiques mon&#233;taires ou budg&#233;taires se r&#233;v&#232;le toujours contre-productive. Il appara&#238;t &#233;galement que le choix d&#8217;un banquier central europ&#233;en trop conservateur d&#233;t&#233;riore le bien-&#234;tre mondial. JEL Classification: E63, F42

Committees versus Individuals: An Experimental Analysis of Monetary Policy Decision-making

We report the results of an experimental analysis of monetary policy decision making under uncertainty. A large sample of economics students played a simple monetary policy game, both as individuals and in committees of five players. Our findings - that groups make better decisions than individuals - accord with previous work by Blinder and Morgan. We also attempt to establish why this is so. Some of the improvement is related to the ability of committees to strip out the effect of bad play, but there is a significant additional improvement, which we associate with players learning from each other’s interest rate decisions.

Monetary and Fiscal Policy Games and Effects of Institutional Differences between the European Union and the Rest of the World

<titre>R&#233;sum&#233;</titre> Les interactions strat&#233;giques entre les autorit&#233;s budg&#233;taires et mon&#233;taires sont &#233;tudi&#233;es dans un mod&#232;le &#224; trois pays. La comparaison des &#233;quilibres non coop&#233;ratifs montre que la solution de Stackelberg avec leadership budg&#233;taire peut &#234;tre analys&#233;e comme un m&#233;canisme de coordination de second rang. La coop&#233;ration intra-zone procure les gains de bien-&#234;tre les plus importants. &#192; l&#8217;inverse, la coordination internationale des seules politiques mon&#233;taires ou budg&#233;taires se r&#233;v&#232;le toujours contre-productive. Il appara&#238;t &#233;galement que le choix d&#8217;un banquier central europ&#233;en trop conservateur d&#233;t&#233;riore le bien-&#234;tre mondial. JEL Classification: E63, F42

The Credibility of Central Bank Announcements

In this paper, we present a monetary policy game in which the central bank has a private forecast of supply and demand shocks. The public needs to form its inflationary expectations and can make use of central bank announcements. However, because of the credibility problem that the central bank faces, the public will not believe a precise announcement. By extending the arrangement proposed by Garfinkel and Oh (1995) to a model that includes private information about both demand and supply shocks, we investigate the feasibility of making imprecise credible announcements concerning the rate of inflation.

Coalition formation in international monetary policy games

This paper analyses coalition formation in monetary policy coordination games between n countries. We show that some but not all countries may join if the decision to be a member of the coalition is incentive-compatible for the individual country. Positive spillovers of the coalition formation process and the resulting free-rider problem limit the stable coalition size: since the coalition members are bound by the union’s discipline, an outsider can successfully export inflation without fearing that the insiders will try to do the same. These ‘gains from staying out’ arise even in the case of symmetric shocks.

Monetary Policy Games and International Migration in a Small Open Economy

The paper shows that international migration may improve the position of both policymakers and unions in small open economies irrespective of whether they cooperate or not. This result implies that both unions and policymakers in small open economies may welcome a further increase in international labor flow in the future. When allowance is made for real GDP per capital considerations on behalf of the policymaker, it is found that aggressive union behavior may increase the inflationary bias. Aggressive unions may insulate themselves, while soft unions lose. The presence of migration does not necessarily lead to a better outcome.

A K% MONEY GROWTH LEADERSHIP RULE IN AN INTERNATIONAL MONETARY POLICY GAME

This paper examines a version of the Friedman k%money growth rule in an open economy monetary policy game. Using the two‐country model proposed by Canzoneri and Henderson (1991), we show that, in response to asymmetric aggregate demand shocks, the Pareto‐efficient outcome can be achieved by a policy that we call a k%money growth leadership rule. Following that rule, one country, the leader, sets her money supply growth rate, and the follower sets her money supply growth rate so as to keep the sum of nominal money supply growth at k%. We show that this policy yields the same outcome as does cooperative equilibrium. We also show that alternative policy rules, such as keeping exchange‐rate adjusted money supply growth at k%, or forming a currency union, will not lead to the Pareto‐efficient outcome in response to these demand shocks. (JEL E5, F3)

Coalition Formation in International Monetary Policy Games

It is well known from the analysis of monetary policy coordination of two countries that coordination often Pareto-dominates the outcome of the non-cooperative game. Hence both countries will have an incentive to form a union when it is certain that the other country will also join. However, in an n-country model, free-riding incentives restrict the size of a stable coalition to less then n countries. Since the coalition members are bound by the union's discipline, an outsider can successfully export inflation without fearing that the insiders will try to do the same. The formation of a large currency bloc is not sustainable since it would impose too much discipline on all participants. However, the co-existence of several smaller currency blocs may be a second-best solution to the free-riding problem of monetary policy coordination.

The Inflation Target and the Structure of Labour Markets: Implications for Common Monetary Policy

Both the optimal inflation target and the optimal degree of output stabilization are found to be conditional on the prevailing wage bargaining structure. If monopolistic wage setters act as strategic leaders of the monetary policy game, an explicit inflation targeting regime removes inflation bias from monetary policy, but does not remove the trade-off related to average level of output and output stabilization. In contrast to usual results on inflation targeting, appointing a central banker who is more conservative than the government leads to welfare gains for society. If centralization within the national labor markets increases in the common monetary policy area, the monetary policy game with regard to the European Central Bank might be conducted under the strategic leadership of trade union confederations. This leads to a Pareto loss.

Monetary Integration and Economic Reform

Recent research in contract theory views ownership as a substitute for complete contracts. Here, this approach is applied to monetary integration. Countries face a coordination problem conducting monetary policy. Negative spillovers ensure uncoordinated policy generates too high inflation. Ex ante, policy makers can undertake politically costly economic reform. This has a positive spillover because it improves the outcome of the monetary policy game. Ex-post contracting over policy may be possible, but it supposed that ex-ante contracting over reform and monetary policy is not. This paper analyses when monetary union is a good substitute for this inability to commit.

A Note on the Role of Ambiguity in a Monetary Policy Game

This paper shows that a policymaker may deliberately choose not to minimize monetary variability. The policymaker has an incentive to create unexpected inflation so as to stimulate economic activity via a Lucas supply curve. In equilibrium, however, the public correctly anticipates the monetary policy and therefore the economy settles to the natural rate of employment with positive inflation. The equilibrium is socially inefficient. Since the slope of the Lucas supply curve is inversely related to the variance of monetary shocks, a positive variance of money growth reduces the policymaker’s incentive to inflate, and therefore may be welfare improving.

The trade off between central bank independence and conservativeness

This paper introduces a parameter for central bank independence in a monetary policy game with a conservative central banker.It tries to explain the optimal degree of central bank independence and conservativeness by four economic and political determinants, both theoretically and empirically.There appears to be a trade off between central bank independence and conservativeness.Then, by comparing the optimal degree of conservativeness and independence with the actual degree of independence, we want to identify the optimal degree of conservativeness for the countries participating in EMU.

Monetary policy games and international migration of labor in interdependent economies

"In this paper we incorporate the possibility of international migration into a monetary policy game played by governments in unionized interdependent economies. We show that contrary to usual presumptions, established by earlier studies that ignore the possibility of international migration, inter-government cooperation in the monetary field may well turn out to be advantageous. This has important implications for the European economies, since it suggests that measures taken towards encouraging international migration within EU [the European Union] will not only harmonize the European labor markets but will also make monetary policy cooperation within Europe, as required by the Maastrict Treaty, more advantageous."

Incomplete Information in Monetary Policy Games: Rules Rather Than a Conservative Central Banker

Time inconsistency in monetary policy can be addressed appointing a conservative central banker. But incomplete information about the central banker's preferences impairs the performance of delegation schemes. Firstly, the ensuing ex‐ante variability of monetary response lowers welfare. Secondly, partial independence schemes may prove inadequate because reputation — not only legal arrangements — defines the actual degree of independence. The incumbent may exploit his reputation to impose too conservative policies whereas, if he lacks reputation, partial independence forces him to accommodate. As a result, simple rules may be preferred.…I do not believe that we should always get the best man for the post; often I fear that we should not even get a tolerable man. (W. Bagehot, The Government of the Bank of England, in ‘Lombard Street’)

Monetary policy uncertainty and inflation: the role of central bank accountability

We analyse the issue of central bank accountability with the aid of a simple monetary policy game with uncertainty about the agent's inflation stabilisation preferences. We find that there may be an important economic role for accountability in addition to its political function of making the central bank answerable to voters through its accountability to the executive. The model suggests that for countries with relatively little central bank independence, or perhaps a poor inflationary track record, significant reductions in inflation can be achieved by lowering monetary policy uncertainty. These reductions are much smaller for inflation-averse central banks, when monetary policy uncertainty is reduced by the same absolute amount. Thus, the effectiveness of accountability – as a means of lowering both inflation and inflation uncertainty – is higher the lower the degree of central bank conservativeness.

STAGFLATIONARY CONSEQUENCES OF PRUDENT MONETARY POLICY IN A UNIONIZED ECONOMY

Stylized models of the policy game between monetary policymakers and the private sector have suggested that disciplinary policy regimes suffer from an inherent inflationary bias and that precommitment to a target rate of inflation may be desirable. This paper shows that, in the presence of labor unions, the monetary policy game can lead to radically different results: a central bank that is completely indifferent to the level of inflation may obtain outcomes with high employment rates and zero inflation while 'prudent,' inflation-averse central banks generate stagflation with positive inflation and low rates of employment. Copyright 1997 by Royal Economic Society.

The Trade Off Between Central Bank Independence and Conservativeness

This paper introduces a parameter for central bank independence in a monetary policy game with a conservative central banker. It tries to explain the optimal degree of central bank independence and conservativeness by four economic and political determinants, both theoretically and empirically. There appears to be a trade off between central bank independence and conservativeness. Then, by comparing the optimal degree of conservativeness and independence with the actual degree of independence, we want to identify the optimal degree of conservativeness for the countries participating in EMU.

MONETARY POLICY GAMES AND COALITIONS IN A TWO-COUNTRY MODEL WITH UNIONISED WAGE SETTING

We show that in interdependent, unionised economies co-operation between wagesetters at home and abroad improves both their own positions and social welfare relative to universal Nash play. Moreover, a move from all-round Nash play to co-operation between home and foreign unions and between home and foreign policymakers may produce Pareto improvements, or outcomes that are preferable to Nash play for the coalition as a whole. However, intra-national coalitions may lack the support of unions. Such coalitions unambiguously improve the policymakers' position. However, in an interdependent world, they do not necessarily make the unions better off relative to other regimes.