Optimal and Sustainable Exchange Rate Regimes: A Simple Game-Theoretic Approach

November 1, 1992

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper examines the question of how to design an optimal and sustainable exchange rate regime in a world economy of two interdependent countries. It develops a Barro-Gordon type two-country model and compares noncooperative equilibria under different assumptions of monetary policy credibility and different exchange rate regimes. Using a two-stage game approach to the strategic choice of policy instruments, it identifies optimal (in a Pare to sense) and sustainable (self-enforcing) exchange rate regimes. The theoretical results indicate that the choice of such regimes depends fundamentally on the credibility of monetary policy commitments by the two countries’ authorities. The nature of shocks to the economies and the substitutability between goods produced in the two countries also play some role. International coordination on instrument choice is necessary to design optimal and sustainable exchange rate regimes.

Subject: Conventional peg, Exchange rate arrangements, Exchange rate flexibility, Exchange rates, Foreign exchange, Monetary base, Money

Keywords: choice of exchange rate regime, Conventional peg, exchange rate, Exchange rate arrangements, exchange rate commitment, Exchange rate flexibility, Exchange rates, foreign authority, Global, home authority, home-authority money supply commitment, maximization problem, Monetary base, noncooperative exchange rate regime, policy instrument, policy rule, reaction function, WP

Pages:
43
Volume:
1992
DOI:
https://doi.org/10.5089/9781451852325.001
Issue:
100
Series:
Working Paper No. 1992/100
Stock No:
WPIEA1001992
ISBN:
9781451852325
ISSN:
1018-5941

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Notes

Examines the question of how to design an optimal and sustainable exchange rate regime in a world economy of two interdependent countries. Also published in Staff Papers, Vol. 40, No. 2, June 1993.

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