Exchange Rate Determination: A Model of the Decisive Role of Central Bank Cooperation and Conflict

Robin Pope, Reinhard Selten, Sebastian Kube, Johannes Kaiser () and Juergen von Hagen ()

Bonn Econ Discussion Papers from University of Bonn, Germany

Abstract: Opinion is divided on whether it is better to have a single world  money or variable exchange rates.  Pope, Selten and von Hagen (2003)  propose that fresh light would be shed via an analysis that allows  for seven complexity impacts on the exchange rate that are  underplayed (where not entirely absent) from current analyses: 1) the  role of official sector, including its central bank; 2) the numerous  official and private sector goals; 3) the disparate degrees of market  power of different sorts of private agents; 4) the documentation that  essentially all shocks to the exchange rate are generated by human  decisions; 5) the non-maximising heuristics that in the complex  economy agents use; 6) heterogenous beliefs.  This paper analyses a  closed form game theoretic solution of version 1 of a model that  combines impacts 1 to 4 with the conventional finance assumption that  all agents maximise their utility.  Impact 1) precludes private  agents being able to destabilise the exchange rate against the  cooperation of the central banks required by the game theoretic  solution.  Impact 4) excludes random events and other exogenous  shocks such as meteors falling from the sky.  The rational maximising  assumption in turn precludes all other sources of shocks and thus any  need for a variable exchange rate to equilibrate after shocks.  We  then modify version 1 of our model substituting for the maximising  assumption impacts 5 to 7, impacts that allow shocks from humans to  be consistently incorporated.  We do so by means of an experimental  investigation which indicates that central bankers less than fully  cooperate, leaving scope for private speculators to support their  preferred currency.  From the viewpoint of the game theoretic  equilibrium, the resultant exchange rate changes render equilibrium  unspecified.  A single world money avoids disruptive exchange rate  changes from less than fully cooperating central banks, exchange rate  changes caused by central bank conflicts and that cannot be  classified as equilibrating.

Keywords: central bank; cooperation; conflict; exchange rate; experiment; market power; heuristics; heterogenous beliefs; personality; interpersonal dynamics; friendship; complex; destabilising speculators, irrational central bankers (search for similar items in EconPapers)
JEL-codes: F31 F33 B40 B59 C79 C90 C91 C92 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-cbe, nep-ifn and nep-mon
Date: Written

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Related works:
Working Paper: Exchange Rate Determination: A Model of the Decisive Role of Central Bank Cooperation and Conflict (2007)
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