On the Credibility of Macroeconomic Reform and Stabilization Policies A Game-theoretical Perspective

The formation of macroeconomic policy is conceptualized as on-going process of interaction between private individuals and a centralized policymaker. This interaction is inherently strategic in nature and lends itself to a gametheoretical treatment. Starting from the basic principle of rational expectations, the analysis advances a theoretical perspective on the related concepts of macroeconomic credibility (time-consistency) and reputation in a developing economy context. Therefore the focus will be on macroeconomic policies aimed at economic stability and structural reform, with the main emphasis on monetary and exchange rate policies dedicated to disinflation. The macroeconomic games described here are an attempt to formalize the process of policy formation which are governed by a dynamic process in which one of the players in the economy, the private sector, form their expectations from the actions of the other player, the government. More specifically, this involves modeling of people’s reactions to announced regime shifts in economic policy over time. The feedback of private behavior on the government’s incentives is an essential element of credibility that has an important impact on the real development of the economy.