Equilibrium Exchange Rate Policies: Complicit Renegotiation-Proof Outcomes

Pierre Mella-Barral and Paolo Vitale

No 2718, CEPR Discussion Papers from Centre for Economic Policy Research

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.

Keywords: Exchange rate management; Renegotiation; Bargaining power; Cross-country wealth transfers (search for similar items in EconPapers)
JEL-codes: C73 F31 F33 (search for similar items in EconPapers)
Date: 2001-03
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Working Paper: Equilibrium Exchange Rate Policies: Complicit Renegotiation-Proof Outcomes (2002)
Working Paper: EQUILIBRIUM EXCHANGE RATE POLICIES: COMPLICIT RENEGOTIATION-PROOF OUTCOMES (2002)
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