The Case for a Symmetric Reaction. Function of the European Central Bank
In a macro-economic framework where the European Central Bank targets individual country data, the nature of strategic interactions between fiscal authorities in the euro-zone can be described as a stag hunt game with (at least) two equilibria that can be pareto-ranked. In fact we show that, because of the indiscriminate nature of its monetary response, an ECB strategy of monetary retaliation to any individual country's over-expenditure affects all eleven countries to the same extent. This collective effect is similar to the teacher's old favorite "all children stay behind in the class if one misbehaves". This mechanism, we show, makes the game between fiscal authorities a multiple equilibria co-ordination game. We subsequently address the problem of equilibrium selection that is of particular importance to co-ordination games. Following Kandori et al. (1993), we apply Harsanyi and Selten's (1988) riskdominance criterion to single out the conditions for fiscal restraint to emerge as the equilibrium selected by interacting actors. Our main conclusions are that the ECB can ensure convergence of fiscal authorities upon the pareto-optimal equilibrium (that is, fiscal restraint) by adopting a reward-oriented, counter-cyclical strategy that compensates fiscal authorities at the output level both for giving up fiscal discretion and for incurring the risk of being hit by a monetary tightening in response to developments elsewhere in the euro-economy. This means that interest rates' movements should smoothen economic fluctuations in order to give economic actors sufficient incentives to maintain restraint.
(This abstract was borrowed from another version of this item.)
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- John C. Harsanyi & Reinhard Selten, 1988. "A General Theory of Equilibrium Selection in Games," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262582384, July.
- Allsopp, Christopher & Vines, David, 1998. "The Assessment: Macroeconomic Policy after EMU," Oxford Review of Economic Policy, Oxford University Press, vol. 14(3), pages 1-23, Autumn.
- Kandori, Michihiro & Mailath, George J & Rob, Rafael, 1993.
"Learning, Mutation, and Long Run Equilibria in Games,"
Econometric Society, vol. 61(1), pages 29-56, January.
- Kandori, M. & Mailath, G.J., 1991. "Learning, Mutation, And Long Run Equilibria In Games," Papers 71, Princeton, Woodrow Wilson School - John M. Olin Program.
- M. Kandori & G. Mailath & R. Rob, 1999. "Learning, Mutation and Long Run Equilibria in Games," Levine's Working Paper Archive 500, David K. Levine.
- Buti, Marco & Franco, Daniele & Ongena, Hedwig, 1998. "Fiscal Discipline and Flexibility in EMU: The Implementation of the Stability and Growth Pact," Oxford Review of Economic Policy, Oxford University Press, vol. 14(3), pages 81-97, Autumn.
- Iversen, Torben, 1998. "Wage Bargaining, Central Bank Independence, and the Real Effects of Money," International Organization, Cambridge University Press, vol. 52(03), pages 469-504, June.
- Barry Eichengreen & Charles Wyplosz, 1998. "The Stability Pact: more than a minor nuisance?," Economic Policy, CEPR;CES;MSH, vol. 13(26), pages 65-113, 04.
- Hall, Peter A. & Franzese, Robert J., 1998. "Mixed Signals: Central Bank Independence, Coordinated Wage Bargaining, and European Monetary Union," International Organization, Cambridge University Press, vol. 52(03), pages 505-535, June. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:wpa:wuwpma:0507009. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.