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A model of the decisive role of central bank cooperation and conflict

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Opinion is divided on whether it is better to have a single world money or variable exchange rates.Pope, Selten and von Hagen (2003) propose that fresh light would be shed via an analysis that allows forseven complexity impacts on the exchange rate that are underplayed (where not entirely absent) fromcurrent analyses: 1) the role of official sector, including its central bank; 2) the numerous official andprivate sector goals; 3) the disparate degrees of market power of different sorts of private agents; 4) thedocumentation that essentially all shocks to the exchange rate are generated by human decisions; 5) thenon-maximising heuristics that in the complex economy agents use; 6) heterogenous beliefs. This paperanalyses a closed form game theoretic solution of version 1 of a model that combines impacts 1 to 4 withthe conventional finance assumption that all agents maximise their utility. Impact 1) precludes privateagents being able to destabilise the exchange rate against the cooperation of the central banks requiredby the game theoretic solution. Impact 4) excludes random events and other exogenous shocks such asmeteors falling from the sky. The rational maximising assumption in turn precludes all other sources ofshocks and thus any need for a variable exchange rate to equilibrate after shocks. We then modifyversion 1 of our model substituting for the maximising assumption impacts 5 to 7, impacts that allowshocks from humans to be consistently incorporated. We do so by means of an experimentalinvestigation which indicates that central bankers less than fully cooperate, leaving scope for privatespeculators to support their preferred currency. From the viewpoint of the game theoretic equilibrium,the resultant exchange rate changes render equilibrium unspecified. A single world money avoidsdisruptive exchange rate changes from less than fully cooperating central banks, exchange rate changescaused by central bank conflicts and that cannot be classified as equilibrating.

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Robin Pope, Reinhard Selten, Sebastian Kube, Johannes Kaiser, J├╝rgen von Hagen

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Adapt according to the presented license agreement and reference the original author.