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

Masahiro Kawai ()

No 1992/100, IMF Working Papers from International Monetary Fund

Abstract: 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.

Keywords: WP; exchange rate; home authority; policy instrument; exchange rate commitment; maximization problem; reaction function; foreign authority; policy rule; choice of exchange rate regime; noncooperative exchange rate regime; home-authority money supply commitment; Exchange rate arrangements; Exchange rates; Exchange rate flexibility; Conventional peg; Monetary base; Global (search for similar items in EconPapers)
Pages: 43
Date: 1992-11-01
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Citations: View citations in EconPapers (5)

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