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https://hdl.handle.net/2142/70777
Description
Title
Monetary Games in Interdependent Economies
Author(s)
Orey, Vasco Maria De Portugal E Castro De
Issue Date
1986
Department of Study
Economics
Discipline
Economics
Degree Granting Institution
University of Illinois at Urbana-Champaign
Degree Name
Ph.D.
Degree Level
Dissertation
Keyword(s)
Economics, Theory
Abstract
This thesis analyzes monetary policy in interdependent economies using game theoretic methods.
We consider a world consisting of two countries and model the real and financial interrelations between them. Using both static and dynamic game theoretic methods we analyze the inter and intratemporal aspects of policy making. The games are considered under both noncooperative or cooperative equilibrium solutions. The Nash, Stackelberg and Consistent Conjectural Variations are the noncooperative solutions used. A Pareto optimal regime and the traditional regimes of flexible and fixed exchange rates are modeled as resulting from cooperative behavior.
We consider a deterministic model of the two economies where goods prices adjust slowly while asset markets are always in equilibrium. For the game generated by a unitary shock in the real exchange rate, we derive the optimal policies corresponding to alternative equilibrium solutions. We show the existence of a clear welfare ranking of the different equilibria arising from a dynamic optimization. In an intertemporal context the traditional regimes of fixed and flexible exchange rates turn out not to be enforceable. Pareto optimal cooperation is the best regime and the Consistent Conjectural Variations equilibrium is dominated, in an intertemporal framework, by the Nash equilibrium.
We also consider a stochastic two country model where agents have rational expectations and study the conduct of monetary policy as the manipulation of the nominal money stocks to neutralize the domestic effects of demand and supply shocks. We establish that some form of strategic behavior should be adopted in the conduct of monetary policy as the traditional regimes of fixed and flexible exchange rates are dominated by the strategic equilibria.
The optimal choice of monetary instrument under strategic conditions is determined in two stages. First, for each pair of policy instruments, minimized welfare costs corresponding to the Nash and Consistent Conjectural Variations equilibrium are determined for each economy. Secondly, Nash equilibrium for the pair of payoff matrices thus obtained is then determined. We show that when both policy makers adopt the Consistent Conjectural Variations equilibrium, welfare costs are independent of the choice of monetary instrument.
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