Coordination and policy traps
By: George-Marios Angeletos, Christian Hellwig [and] Alessandro Pavan
Contributors: Hellwig, Christian; Pavan, Alessandro; Massachusetts Institute of Technology. Dept. of Economics
Series: Working paper series / Massachusetts Institute of Technology, Dept. of Economics -- working paper 03-18; Working paper (Massachusetts Institute of Technology. Dept. of Economics) -- no. 03-18.
Publisher: Massachusetts Institute of Technology, Dept. of Economics
Published: 2003
Place of publication: Cambridge, MA
Language: eng
Number of pages: 36
Description: 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 different 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. Keywords: Global Games, Coordination, Signaling, Speculative Attacks, Currency Crises, Multiple Equilibria. JEL Classification: C72, D82, D84, E5, E6, F31.
Notes: "May 2003."

Includes bibliographical references (p. 34-36).

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