Optimal Macroeconomic Policies in a Monetary Union: A Dynamic Game Analysis

In this paper we present an application of the dynamic tracking games framework to a monetary union. We use a small stylized nonlinear two-country macroeconomic model of a monetary union (MUMOD1) to analyse the interactions between fiscal (governments) and monetary (common central bank) policy makers, assuming different objective functions of these decision makers. Using the OPTGAME algorithm we calculate solutions for four game strategies: one cooperative (Pareto optimal) and three non-cooperative games: the Nash game for the open-loop information pattern, the Nash game for the feedback information pattern, and the Stackelberg game for the feedback information pattern. Applying the OPTGAME algorithm to the MUMOD1 model we show how the policy makers react to demand and supply shocks according to different solution concepts. Some comments are given on possible applications to the recent sovereign debt crisis in Europe.