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Central bank and government in a speculative attack model

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  • Giuseppe Cappelletti

    ()
    (Bank of Italy)

  • Lucia Esposito

    ()
    (Bank of Italy)

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    Abstract

    This paper studies the interaction between monetary and fiscal authorities while investors are coordinating on a speculative attack. The authorities want to achieve specific targets for output and inflation but also to avoid a regime change (i.e. sovereign default). They use the traditional policy instruments. The model examines the informational role of simultaneous implementation of monetary and fiscal policies in coordination environments. While endogenous information generated by the intervention of one policy maker has been shown to lead to multiple equilibria, we show that if the actions chosen by the central bank and the government not only deliver information to the markets but also influence the fundamentals of the economy, when the authorities have a strong incentive to preserve the status quo over other objectives, then there is no equilibrium in which investors' strategies depend monotonically on their private information on fundamentals.

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    File URL: http://www.bancaditalia.it/pubblicazioni/econo/temidi/td13/td934_13/en_td934/en_tema_934.pdf
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    Bibliographic Info

    Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 934.

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    Date of creation: Sep 2013
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    Handle: RePEc:bdi:wptemi:td_934_13

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    Web page: http://www.bancaditalia.it
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    Related research

    Keywords: global games; complementarities; signaling; self-fulfilling expectations; multiple equilibria; crises; regime change; policy interactions;

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    References

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    1. George-Marios Angeletos & Christian Hellwig & Alessandro Pavan, 2005. "Signaling in a Global Game: Coordination and Policy Traps," Discussion Papers 1400, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    2. Carlsson, H. & Van Damme, E., 1990. "Global Games And Equilibrium Selection," Papers 9052, Tilburg - Center for Economic Research.
    3. Heinemann, Frank & Illing, Gerhard, 2002. "Speculative attacks: Unique equilibrium and transparency," Munich Reprints in Economics 19430, University of Munich, Department of Economics.
    4. Frank Heinemann & Rosemarie Nagel & Peter Ockenfels, 2004. "The Theory of Global Games on Test: Experimental Analysis of Coordination Games with Public and Private Information," Econometrica, Econometric Society, vol. 72(5), pages 1583-1599, 09.
    5. George-Marios Angeletos & Christian Hellwig & Alessandro Pavan, 2007. "Dynamic Global Games of Regime Change: Learning, Multiplicity, and the Timing of Attacks," Econometrica, Econometric Society, vol. 75(3), pages 711-756, 05.
    6. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
    7. Iván Werning & George-Marios Angeletos, 2006. "Crises and Prices: Information Aggregation, Multiplicity, and Volatility," American Economic Review, American Economic Association, vol. 96(5), pages 1720-1736, December.
    8. Christophe Chamley, 1999. "Coordinating Regime Switches," The Quarterly Journal of Economics, MIT Press, vol. 114(3), pages 869-905, August.
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