Coordination and Policy Traps / George-Marios Angeletos, Christian Hellwig, Alessandro Pavan.

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Angeletos, George-Marios

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w9767.Publication details: Cambridge, Mass. National Bureau of Economic Research 2003.Description: 1 online resource: illustrations (black and white)Subject(s):

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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.

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Item type	Home library	Collection	Call number	Status	Date due	Barcode	Item holds
Working Paper	Biblioteca Digital	Colección NBER	nber w9767 (Browse shelf(Opens below))	Not For Loan

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June 2003.

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.