Tacit Collusion under Interest Rate Fluctuations

When collusive agreements are illegal, oligopolies must rely on the threat of future price wars to sustain collusion. If firms’ objective is to maximize the present value of profits, the shadow of that threat changes with the interest rate. That is, the interest rate determines how much firms discount the future, and this affects the level of collusion that can be supported. In an environment of identical firms, price competition and changing interest rate (and hence changing discount factor) I characterize the optimal tacit collusion equilibrium and show that it displays the following properties: 1) the higher the discount factor the higher the equilibrium prices and profits, 2) the higher the volatility of the discount factor the lower the equilibrium prices and profits, and 3) as expected, an increase in the number of firms reduces the scope of collusive behavior.