Exchange Rate Determination: A Model of the Decisive Role of Central Bank Cooperation and Conflict
AbstractOpinion is divided on whether it is better to have a single world Â money or variable exchange rates. Â Pope, Selten and von Hagen (2003) Â propose that fresh light would be shed via an analysis that allows Â for seven complexity impacts on the exchange rate that are Â underplayed (where not entirely absent) from current analyses: 1) the Â role of official sector, including its central bank; 2) the numerous Â official and private sector goals; 3) the disparate degrees of market Â power of different sorts of private agents; 4) the documentation that Â essentially all shocks to the exchange rate are generated by human Â decisions; 5) the non-maximising heuristics that in the complex Â economy agents use; 6) heterogenous beliefs. Â This paper analyses a Â closed form game theoretic solution of version 1 of a model that Â combines impacts 1 to 4 with the conventional finance assumption that Â all agents maximise their utility. Â Impact 1) precludes private Â agents being able to destabilise the exchange rate against the Â cooperation of the central banks required by the game theoretic Â solution. Â Impact 4) excludes random events and other exogenous Â shocks such as meteors falling from the sky. Â The rational maximising Â assumption in turn precludes all other sources of shocks and thus any Â need for a variable exchange rate to equilibrate after shocks. Â We Â then modify version 1 of our model substituting for the maximising Â assumption impacts 5 to 7, impacts that allow shocks from humans to Â be consistently incorporated. Â We do so by means of an experimental Â investigation which indicates that central bankers less than fully Â cooperate, leaving scope for private speculators to support their Â preferred currency. Â From the viewpoint of the game theoretic Â equilibrium, the resultant exchange rate changes render equilibrium Â unspecified. Â A single world money avoids disruptive exchange rate Â changes from less than fully cooperating central banks, exchange rate Â changes caused by central bank conflicts and that cannot be Â classified as equilibrating.
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Bibliographic InfoPaper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number bgse18_2007.
Date of creation: Dec 2007
Date of revision:
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Postal: Bonn Graduate School of Economics, University of Bonn, Adenauerallee 24 - 26, 53113 Bonn, Germany
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Web page: http://www.bgse.uni-bonn.de
central bank; cooperation; conflict; exchange rate; experiment; market power; heuristics; heterogenous beliefs; personality; interpersonal dynamics; friendship; complex; destabilising speculators; irrational central bankers;
Other versions of this item:
- Robin Pope & Reinhard Selten & Sebastian Kube & Johannes Kaiser & JÃ¼rgen von Hagen, 2007. "Exchange Rate Determination: A Model of the Decisive Role of Central Bank Cooperation and Conflict," Bonn Econ Discussion Papers bgse19_2007, University of Bonn, Germany.
- F31 - International Economics - - International Finance - - - Foreign Exchange
- F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
- B40 - Schools of Economic Thought and Methodology - - Economic Methodology - - - General
- B59 - Schools of Economic Thought and Methodology - - Current Heterodox Approaches - - - Other
- C79 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Other
- C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General
- C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
- C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-03-08 (All new papers)
- NEP-CBA-2008-03-08 (Central Banking)
- NEP-CBE-2008-03-08 (Cognitive & Behavioural Economics)
- NEP-IFN-2008-03-08 (International Finance)
- NEP-MON-2008-03-08 (Monetary Economics)
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- Robin Pope, 2009. "Beggar-Thy-Neighbour Exchange Rate Regime Misadvice from Misapplications of Mundell (1961 ) and the Remedy," The World Economy, Wiley Blackwell, vol. 32(2), pages 326-350, 02.
- Christian Bauer & Bernhard Herz, 2009. "The Dynamics of Financial Crises and the Risk to Defend the Exchange Rate," Research Papers in Economics 2009-03, University of Trier, Department of Economics.
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