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Monetary Policy under Leviathan Currency Competition

  • Parag Waknis

    (University of Connecticut and University of Massachusetts Dartmouth)

In this paper, we use a dual currency Lagos-Wright model to explore the nature of optimal monetary policy under currency competition using different timing protocols. The central banks are utility maximizing players. To characterize equilibrium with reputation, we model the centralized market sub period of the Lagos-Wright economy as an infinitely repeated game between the two Leviathan central banks (long run players) and a continuum of competitive agents (short run players). Concentrating on Markov strategies in such a game shows that the Markov perfect equilibrium features highest inflation tax. However, allowing for reputation concerns improves the inflation outcome. Such a game typically features multiple equilibriums but the competition between the banks allows the use of renegotiation proof-ness as an equilibrium selection mechanism. Accordingly, equilibrium featuring the lowest inflation tax is weakly renegotiation proof, suggesting that better inflation outcome is more likely in the case of Leviathan currency competition than in the single Leviathan bank case.

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File URL: http://web2.uconn.edu/economics/working/2011-21.pdf
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Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2011-21.

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Length: 28 pages
Date of creation: Oct 2011
Date of revision:
Handle: RePEc:uct:uconnp:2011-21
Contact details of provider: Postal: University of Connecticut 365 Fairfield Way, Unit 1063 Storrs, CT 06269-1063
Phone: (860) 486-4889
Fax: (860) 486-4463
Web page: http://www.econ.uconn.edu/

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  1. van Damme, Eric, 1989. "Renegotiation-proof equilibria in repeated prisoners' dilemma," Journal of Economic Theory, Elsevier, vol. 47(1), pages 206-217, February.
  2. Fernando M. Martin, 2004. "A Positive Theory of Government Debt," Macroeconomics 0408013, EconWPA, revised 12 Oct 2004.
  3. Chow, Gregory C., 1997. "Dynamic Economics: Optimization by the Lagrange Method," OUP Catalogue, Oxford University Press, number 9780195101928, March.
  4. Allen Head & Shouyong Shi, 2000. "A Fundamental Theory of Exchange Rates and Direct Currency Trades," Working Papers 993, Queen's University, Department of Economics.
  5. George Selgin, 2008. "Milton Friedman and the Case against Currency Monopoly," Cato Journal, Cato Journal, Cato Institute, vol. 28(2), pages 287-301, Winter.
  6. Soller, E.V. & Waller, C., 1997. "A Search Theoretic Model of Legal and Illegal Currency," Papers 97-003, Indiana - Center for Econometric Model Research.
  7. Gabriele Camera & Ben Craig & Christopher J. Waller, 2003. "Currency competition in a fundamental model of money," Working Paper 0311, Federal Reserve Bank of Cleveland.
  8. Craig, Ben & Waller, C.J.Christopher J., 2004. "Dollarization and currency exchange," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 671-689, May.
  9. Lotz, Sebastien, 2004. "Introducing a new currency: Government policy and prices," European Economic Review, Elsevier, vol. 48(5), pages 959-982, October.
  10. Hongfei Sun, 2006. "Aggregate Uncertainty, Money and Banking," 2006 Meeting Papers 58, Society for Economic Dynamics.
  11. Parag Waknis, 2011. "Endogenous Monetary Policy: A Leviathan Central Bank in a Lagos-Wright Economy," Working papers 2011-20, University of Connecticut, Department of Economics.
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