Interactions among Private Investors and Government Policies : Rules versus Discretion

Abstract

Models fiscal policy interactions between fiscal authorities and private investors in the foreign exchange market in a game‐theoretic framework. Using a two‐period game, I consider the credible and noncredible announcements of the domestic fiscal authority with respect to the stance of its future fiscal policy. Each country faces a trade‐off between its current account and budget deficit objectives and time‐inconsistency arises due to lack of a sufficient number of policy instruments. For this game I derive explicitly the time consistent and precommitment policies for the domestic fiscal authority and explain that precommitment is welfare improving relative to the time‐consistent policy. In a two‐country framework, both precommitment with respect to the private sector and co‐operation between the two policymakers tend to improve welfare.

Citation

Fountas, S. (1994), "Interactions among Private Investors and Government Policies : Rules versus Discretion", Journal of Economic Studies, Vol. 21 No. 2, pp. 38-56. https://doi.org/10.1108/01443589410062977