“Core” and “Periphery” in a Monetary Union: A Macroeconomic Policy Game

Abstract

Abstract:We use a dynamic game model of a two-country monetary union to study the impacts of an exogenous fall in aggregate demand, the resulting increase in public debt, and the consequences of a sovereign debt haircut for a member country or bloc of the union. In this union, the governments of participating countries pursue national goals when deciding on fiscal policies, whereas the common central bank's monetary policy aims at union-wide objective variables. The union considered is asymmetric, consisting of a "core" with lower initial public debt, and a "periphery" with higher initial public debt. The ''periphery'' may experience a haircut due to high level of its sovereign debt. We calculate numerical solutions of the dynamic game between the governments and the central bank using the OPTGAME algorithm. We show that a haircut as modeled in our study is disadvantageous for both the "core" and the "periphery" of the monetary union. Moreover, the cooperative solution is preferable to the noncooperative equilibrium solution (both without and with a haircut), providing an argument for coordinated fiscal policies in a monetary union.

Game of Thrones: Accommodating Monetary Policies in a Monetary Union

“…In this paper we extend previous research in [9] and [10] by analysing a three-country monetary union. In contrast to the MUMOD1 model, MUMOD2 consists of a joint central bank and three countries (or blocs of countries): a "core" (country 1) and two periphery countries: a "thrifty" country (2) with high preference for sustainable debt policy and a "thriftless" country (3) with low preference for the sovereign debt target.…”

“…[8]). In previous papers, we developed a small macroeconomic model for a monetary union with some features of the Euro Area and investigated the interaction between monetary and fiscal policy using dynamic game theory ( [9,10]). Using the macroeconomic model MUMOD1 for a monetary union with a joint central bank and two governments (one with high and one with low preferences for balanced budgets versus output, called core and periphery), we determined cooperative and noncooperative fiscal and monetary policies and showed that cooperative policies outperform noncooperative ones.…”

“…The three countries (or blocs of countries) forming the union are called the core, thrifty periphery and thriftless periphery. The distinction between a core of countries with relatively sound public finances and a periphery with high public debt and deficits is often invoked when analysing the tensions in the Euro Area and has also been used in previous work by us [9,10]. What is new here is the splitting of the periphery into a country (or a bloc of countries) which aims at reducing its public debt more quickly, even at the price of slower recovery from the slump, and a country (or a bloc of countries) with a dominant preference for curbing growth and employment in the short run, even at the expense of still higher public debt.…”

“Haircuts” for the EMU periphery: virtue or vice?

“…For our study we use an extended version of the MUMOD1 model as presented in Blueschke and Neck (2011). This is a simplified macroeconomic model of a monetary union consisting of two countries (or two blocs of countries) with a common central bank.…”

The Eurozone needs exit rules

“…For example, Blueschke and Neck (2011) use a dynamic game model of a two-country monetary union to study the impacts of an exogenous fall in aggregate demand, the resulting increase in public debt, and the consequences of a sovereign debt haircut for a member country or bloc of the union. In their currency area, the governments of participating members pursue national goals when deciding on fiscal policies, whereas the common central bank's monetary policy aims at union-wide objective variables.…”