The game-theoretic literature on monetary policy in open economies has traditionally concluded that central banks should implement monetary policy in a cooperative fashion. This paper considers an alternative mechanism for internalizing the external effects: in the first stage, governments cooperatively design central banks' objective functions; in the second stage, central banks implement monetary policy without cooperation. Although this regime lacks flexibility to deal with asymmetric shocks, it presents important advantages in relation to the former scenario: first, it enjoys more credibility; second, it entails lower coordination and information costs; and finally, it hampers unilateral manipulation of central banks' objectives. Copyright 2000 by Blackwell Publishing Ltd.
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