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

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  • Masahiro Kawai

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.

Suggested Citation

  • Masahiro Kawai, 1992. "Optimal and Sustainable Exchange Rate Regimes: A Simple Game-Theoretic Approach," IMF Working Papers 1992/100, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:1992/100
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    Citations

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    Cited by:

    1. George S. Tavlas, 1993. "The ‘New’ Theory of Optimum Currency Areas," The World Economy, Wiley Blackwell, vol. 16(6), pages 663-685, November.
    2. Hansmann, Ulrich H.E., 1997. "Simulated annealing with Tsallis weights a numerical comparison," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 242(1), pages 250-257.
    3. Andrew Hughes Hallett & Ella Kavanagh, 2001. "Inflation Under Alternative Exchange Rate Regimes: What Happens When Countries Differ in Size?," Open Economies Review, Springer, vol. 12(2), pages 145-161, April.
    4. Hansmann, Ulrich H.E. & Okamoto, Yuko, 1994. "Comparative study of multicanonical and simulated annealing algorithms in the protein folding problem," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 212(3), pages 415-437.
    5. Jochem, Axel, 1999. "Währungspolitische Interdependenz der EU-Beitrittskandidaten und die Wahl eines geeigneten Wechselkurssystems," Working Papers in Economics 1999,5, Bundeswehr University Munich, Economic Research Group.

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