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Equilibrium Exchange Rate Policies: Complicit Renegotiation-Proof Outcomes

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  • Pierre Mella-Barral
  • Paolo Vitale

Abstract

Countries can repeatedly and opportunistically renegotiate the terms of agreements to which they can only complicitly assent. Therefore, when attempting to coordinate exchange rate policies, they continuously play partnership games. We develop a reduced form model of exchange rate management where, as a starting point, (a) sequences of discrete realignments and (b) shared intervention are desirable. We show that the implementation of the ex-ante optimal policy suffers from severe time-inconsistencies. We analyse the Stackelberg equilibria of the stochastic differential game played by partner countries. We find that equilibrium complicit renegotiation-proof policies are supported by net cross-country wealth transfers from the weaker to the stronger bargaining power country. Our theoretical results provide a game-theoretic interpretation of the evolution of monetary arrangements in Europe and the emergence of EMU.
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  • Pierre Mella-Barral & Paolo Vitale, 2002. "Equilibrium Exchange Rate Policies: Complicit Renegotiation-Proof Outcomes," Computing in Economics and Finance 2002 181, Society for Computational Economics.
    • Handle: RePEc:sce:scecf2:181
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    Keywords

    Exchange Rate Management;

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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