Monetary policy interaction within or without an exchange-rate arrangement |
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Authors: | Daniel Gros Timothy Lane |
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Institution: | (1) Centre of European Policy Studies, Brussels;(2) Catholic University of Leuven, Belgium;(3) International Monetary Fund, USA |
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Abstract: | In a simple stochastic two-country model in which each country uses monetary policy to offset shocks that impinge on its national income, the policy rule chosen by each country is affected by the rule chosen by the other. A monetary union emerges as a Nash equilibrium (and is Pareto optimal) if the variance of shocks affecting the real exchange rate is small. An exchange-rate arrangement, and in particular a system of exchange-rate bands such as the European Monetary System (EMS), may create a need for more policy cooperation and may give scope for strategic asymmetries. |
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Keywords: | EMS exchange-rate feedback Nash equilibrium asymmetric policy exchange-rate bands |
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