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

_IMF Working Papers, November 1, 1992_

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## Bibliographic details
- Authors: Masahiro Kawai
- Published: November 1, 1992
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451852325.001

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### Research Question and Framework
- Examines how to design an optimal and sustainable exchange rate regime in a world economy of two interdependent countries.
- Develops a Barro-Gordon type two-country model.
- Uses a two-stage game approach to the strategic choice of policy instruments.
- Compares noncooperative equilibria under different assumptions of monetary policy credibility and different exchange rate regimes.

### Key Theoretical Findings
- Identifies regimes that are optimal (in a Pareto sense) and sustainable (self-enforcing).
- The choice of optimal and sustainable regimes depends fundamentally on the credibility of monetary policy commitments by the two countries’ authorities.
- The nature of shocks to the economies plays a role in regime selection.
- The substitutability between goods produced in the two countries also influences the choice of regime.
- International coordination on instrument choice is necessary to design optimal and sustainable exchange rate regimes.

### Policy Implications and Recommendations
- Strengthen credibility of monetary policy commitments to broaden the set of sustainable and Pareto-optimal exchange rate regimes.
- Consider the cross-country nature of shocks and the degree of goods substitutability when selecting exchange rate arrangements.
- Pursue international coordination on instrument choice to achieve regimes that are both optimal and self-enforcing.

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/30/optimal-and-sustainable-exchange-rate-regimes-a-simple-game-theoretic-approach-850_