Optimal Decision Rules in a Monetary Union

This paper develops a dynamic game model to study strategic interactions between the decision-makers in a monetary union. In such a union, governments of the participating countries pursue national goals when deciding on fiscal policies, whereas the common central bank’s monetary policy aims at union-wide objective variables. Considering the example of a negative demand shock, we show how different solution concepts for the dynamic game between the common central bank and the national governments can be used as models of a conflict between national and supra-national institutions (noncooperative Nash equilibrium) and of coordinated policy-making (cooperative Pareto solutions).