Stochastic Reaction Strategies in the Barro-Gordon Framework: Support for a Low Inflation Equilibrium

26 Pages Posted: 16 Jan 2008 Last revised: 1 Feb 2010

See all articles by Christian-Oliver Ewald

Christian-Oliver Ewald

University of Glasgow; Center for Dynamic Macroeconomic Analysis, University of St. Andrews - School of Economics and Finance

Johannes Geissler

University of St Andrews - School of Economics and Finance

Date Written: January 28, 2010

Abstract

We study a game theoretic model of the conflict which arises between a monetary authority and the private sector with regard to the inflation-rate. Building on the simple static Barro and Gordon model, we assume that rather than playing a one shot game, the monetary authority and private sector interact with each other repeatedly for an infinite number of times. Both, the monetary authorities's and the private sector's reactions are assumed to be stochastic in the form of fixed behavioral transition probabilities. These probabilities are interpreted as strategies in a new game. We study the set of Nash-equilibira of this new game and how these correspond to the classical discretionary Nash-equilibrium identified by Barro and Gordon as well as the classical Non-Nash low inflationary state. In contrast to Barro and Gordon (1983a) we show that the low-inflationary state can be realized as a Nash-equilibrium in our model and in contrast to Barro and Gordon (1983b) we do not rely on punishment strategies, therefore addressing the concerns on credible punishment raised by al-Nowaihi and Levine.

Keywords: Monetary Policy, Inflation, Game Theory, Stochastic Reaction Strategies

JEL Classification: C60, C70, C73, E31, E52

Suggested Citation

Ewald, Christian-Oliver and Geissler, Johannes, Stochastic Reaction Strategies in the Barro-Gordon Framework: Support for a Low Inflation Equilibrium (January 28, 2010). Available at SSRN: https://ssrn.com/abstract=1012566 or http://dx.doi.org/10.2139/ssrn.1012566

Christian-Oliver Ewald

University of Glasgow ( email )

Adam Smith Building
Glasgow, Scotland G12 8RT
United Kingdom

Center for Dynamic Macroeconomic Analysis, University of St. Andrews - School of Economics and Finance ( email )

Castlecliffe
The Scores
St. Andrews, Fife KY16 9AL
United Kingdom
+44(0)1334 462435 (Phone)

HOME PAGE: http://www.maths.usyd.edu.au/u/ewald/

Johannes Geissler (Contact Author)

University of St Andrews - School of Economics and Finance ( email )

The Scores, Castlecliff
St. Andrews, Fife KY16 8RD
United Kingdom

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