Exchange Rate Management in Interdependent Economies: From Williamsburg to Louvre

The theoretical part of this book analyzes non-co-operative and co-operative policies of exchange rate management within a formal two-country, game-theoretic framework, where interventions are fully neutralized and signal future changes in monetary policy. This analysis incorporates two novel factors crucial for understanding real-world intervention experience: partial credibility and non-rational expectations. In contrast to traditional models of the repeated games literature where reputational effects establish full credibility, in the theory presented here central bank credibility problems (towards the private sector and other countries) cannot be eliminated. The empirical section of the study investigates whether Bundesbank interventions in the US dollar market between 1983-87 actually served as signals of future changes in the monetary base. By using several alternative models of expectation formation, the study cannot uncover any favourable evidence for this hypothesis. Strikingly, this result emerges for both unilateral and co-ordinated intervention policies.