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Working Papers (1997), ESSEC Business School

Reputation in a Model of Exchange Rate Policy with Incomplete Information

BESANCENOT D., VRANCEANU Radu

Inspired by the contemporary process of European monetary integration, this paper analyzes exchange rate policy as a finite horizon sequential game under incomplete information of the private agents over the priorities of the central bank. The policymaker has two conflicting objectives: stimulating activity and preserving the parity of the currency. It will be shown that the game presents a perfect Bayesian equilibrium, the most interesting case deals with the pooling situation, where in the central bank undertakes a policy of strong currency during an introductory period, and devaluates in the very few moments before the transfer of its functions to the supra-national central bank. The model suggests a rationale for the persistent risk premium on interest rates in the countries applying for the European Monetary Union.

BESANCENOT, D. and VRANCEANU, R. (1997). Reputation in a Model of Exchange Rate Policy with Incomplete Information. ESSEC Business School.