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Exchange Rate Determination: A Model of the Decisive Role of Central Bank Cooperation and Conflict

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Author Info

  • Robin Pope
  • Reinhard Selten
  • Sebastian Kube
  • Johannes Kaiser
  • Jürgen von Hagen

    ()

Abstract

Opinion is divided on whether it is better to have a single world  money or variable exchange rates.  Pope, Selten and von Hagen (2003)  propose that fresh light would be shed via an analysis that allows  for seven complexity impacts on the exchange rate that are  underplayed (where not entirely absent) from current analyses: 1) the  role of official sector, including its central bank; 2) the numerous  official and private sector goals; 3) the disparate degrees of market  power of different sorts of private agents; 4) the documentation that  essentially all shocks to the exchange rate are generated by human  decisions; 5) the non-maximising heuristics that in the complex  economy agents use; 6) heterogenous beliefs.  This paper analyses a  closed form game theoretic solution of version 1 of a model that  combines impacts 1 to 4 with the conventional finance assumption that  all agents maximise their utility.  Impact 1) precludes private  agents being able to destabilise the exchange rate against the  cooperation of the central banks required by the game theoretic  solution.  Impact 4) excludes random events and other exogenous  shocks such as meteors falling from the sky.  The rational maximising  assumption in turn precludes all other sources of shocks and thus any  need for a variable exchange rate to equilibrate after shocks.  We  then modify version 1 of our model substituting for the maximising  assumption impacts 5 to 7, impacts that allow shocks from humans to  be consistently incorporated.  We do so by means of an experimental  investigation which indicates that central bankers less than fully  cooperate, leaving scope for private speculators to support their  preferred currency.  From the viewpoint of the game theoretic  equilibrium, the resultant exchange rate changes render equilibrium  unspecified.  A single world money avoids disruptive exchange rate  changes from less than fully cooperating central banks, exchange rate  changes caused by central bank conflicts and that cannot be  classified as equilibrating.

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Bibliographic Info

Paper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number bgse18_2007.

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Length: 33
Date of creation: Dec 2007
Date of revision:
Handle: RePEc:bon:bonedp:bgse18_2007

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Postal: Bonn Graduate School of Economics, University of Bonn, Adenauerallee 24 - 26, 53113 Bonn, Germany
Fax: +49 228 73 6884
Web page: http://www.bgse.uni-bonn.de

Related research

Keywords: central bank; cooperation; conflict; exchange rate; experiment; market power; heuristics; heterogenous beliefs; personality; interpersonal dynamics; friendship; complex; destabilising speculators; irrational central bankers;

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Cited by:
  1. 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.
  2. 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.

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