Macroeconomic policies in a monetary union: a game-theoretic analysis
Apr 21th, 2016
University of Klagenfurt
Abstract:The financial and economic crisis of 2007–2010, was the most severe contraction of advanced economies since the Great Depression of the 1930s. Fiscal policy makers reacted on this event by expansionary policies even though many countries started into the crisis with already high public debt and deficits. Monetary policy mostly accommodated the expansionary course of action by governments, leading to unprecedented low levels of interest rates in the developed economies. It is now widely agreed that this accommodating monetary policy together with the fiscal expansion during the early phase of the Great Recession prevented it to develop into a disaster like the Great Depression. Although economic growth after the crisis did not return to previous rates in most of the industrialized countries, their economies have recovered and are seen to be on a path towards slower but positive growth by now.However, there is a notable exception to this observation, namely the European Union and the Euro Area in particular. Especially in the southern countries, policy makers still struggle with high unemployment, low or negative growth, and a lack of economic dynamics similar to the “eurosclerosis” of the 1970s and 1980s. One reason for this adverse development can be seen in the heterogeneity of the Euro Area state of economic development, combined with unfavourable effects of the “one size fits all” monetary union.In this paper, we examine some key aspects of such interactions between several governments with different preferences and a common central bank, which is formally independent but accountable to the public in the area of the monetary union. Dynamic game theory methods are used for this analysis. Applying the OPTGAME algorithm, we show how the policy makers react to adverse shocks according to different cooperative and non-cooperative solution concepts.