Coordination and Policy Traps

39 Pages Posted: 7 Jun 2003 Last revised: 3 Nov 2010

See all articles by George-Marios Angeletos

George-Marios Angeletos

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Christian Hellwig

University of Toulouse 1 - Toulouse School of Economics (TSE)

Alessandro Pavan

Northwestern University

Multiple version iconThere are 2 versions of this paper

Date Written: June 2003

Abstract

This paper examines the ability of a policy maker to control equilibrium outcomes in an environment where market participants play a coordination game with information heterogeneity. We consider defense policies against speculative currency attacks in a model where speculators observe the fundamentals with idiosyncratic noise. The policy maker is willing to take a costly policy action only for moderate fundamentals. Market participants can use this information to coordinate on di.erent responses to the same policy action, thus resulting in policy traps, where the devaluation outcome and the shape of the optimal policy are dictated by self-fulfilling market expectations. Despite equilibrium multiplicity, robust policy predictions can be made. The probability of devaluation is monotonic in the fundamentals, the policy maker adopts a costly defense measure only for a small region of moderate fundamentals, and this region shrinks as the information in the market becomes precise.

Suggested Citation

Angeletos, George-Marios and Hellwig, Christian and Pavan, Alessandro, Coordination and Policy Traps (June 2003). NBER Working Paper No. w9767. Available at SSRN: https://ssrn.com/abstract=414265

George-Marios Angeletos (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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Christian Hellwig

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

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Alessandro Pavan

Northwestern University ( email )

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847-491-7001 (Fax)

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