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