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

Author

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

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.

Suggested Citation

  • Pope, Robin & Selten, Reinhard & Kube, Sebastian & Kaiser, Johannes & von Hagen, Jürgen, 2007. "Exchange Rate Determination: A Model of the Decisive Role of Central Bank Cooperation and Conflict," Bonn Econ Discussion Papers 18/2007, University of Bonn, Bonn Graduate School of Economics (BGSE).
    • Handle: RePEc:zbw:bonedp:182007
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    Cited by:

    1. Pope, Robin & Selten, Reinhard & Kube, Sebastian & von Hagen, Jürgen, 2009. "Managed Floats to Damp Shocks like 1982-5 and 2006-9: Field and Laboratory Evidence for Chinese Interest in a Single World Currency," Bonn Econ Discussion Papers 26/2009, University of Bonn, Bonn Graduate School of Economics (BGSE).
    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, February.

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    More about this item

    Keywords

    central bank; cooperation; conflict; exchange rate; experiment; market power; heuristics; heterogenous beliefs; personality; interpersonal dynamics; friendship; complex; destabilising speculators; irrational central bankers;
    All these keywords.

    JEL classification:

    • 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

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