The Interaction between the Central Bank and Government in Tail Risk Scenarios

21 Pages Posted: 19 Oct 2012 Last revised: 27 Mar 2013

See all articles by Jan Willem van den End

Jan Willem van den End

De Nederlandsche Bank

Marco Hoeberichts

De Nederlandsche Bank - Research Department

Date Written: March 25, 2013

Abstract

We analyse the relationship between tail risk and crisis measures by governments and the central bank. Using an adjusted Merton model in a game theoretical set-up, the analysis shows that the participation constraint for interventions by the central bank and the governments is less binding if the risk of contagion is high. The strategic interaction between governments and the central bank also influences the effectiveness of the interventions. A joint effort of both the governments and central bank leads to a better outcome. To prevent a bad equilibrium a sizable commitment by both players is required. Our stylized model sheds light on the strategic interaction between EMU governments and the Eurosystem in the context of the Outright Monetary Transactions program (OMT).

Keywords: Financial crisis, Monetary policy, Central banks, Policy coordination

JEL Classification: E42, E52, E61, G01, G18

Suggested Citation

van den End, Jan Willem and Hoeberichts, Marco M., The Interaction between the Central Bank and Government in Tail Risk Scenarios (March 25, 2013). De Nederlandsche Bank Working Paper No. 352. Available at SSRN: https://ssrn.com/abstract=2163503 or http://dx.doi.org/10.2139/ssrn.2163503

Jan Willem van den End (Contact Author)

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

Marco M. Hoeberichts

De Nederlandsche Bank - Research Department ( email )

P.O. Box 98
1000 AB Amsterdam
Netherlands
+31-20-524 2890 (Phone)
+31-20-524 2529 (Fax)

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