Green Central Banking and Game Theory: The Chicken Game approach

This paper investigates the determinants of the probability that a cen- tral bank chooses to make its financial sector green. We derive a mixed- strategy Nash equilibrium from a strategic setting of two monetary au- thorities choosing simultaneously between the alternatives of greening and conducting business as usual. Using a very general setup, we obtain a model that nests most of the usual 2×2-situations in game theory. “Green†avoids a country’s contribution to an externality experienced by both, but also encompasses a sacrifice of slowing down economic performance. The prob- ability of greening is found to decrease whenever “greening†means a larger sacrifice for the other country, while it increases with the size of at least one of the two countries, the rate of internalization applied to the externality as well as the severity of this externality. Unlike the typical (pure) free-riding approach to international coordination on environmental issues, we find some willingness of countries to sacrifice wealth for the sake of avoiding a worst case. In a repeated setting, cooperative solutions can be estab- lished. The influence of discounting on the stability of these solutions is ambiguous. Finally, the model allows us to sketch the path along which the structure of our world’s climate game may evolve over time.