Pareto Equilibrium and Optimal Loss Function for Monetary and Fiscal Policymakers in a Cooperative Game, Considering Government Uncertainty in Achieving Budget Revenue

Document Type : Research Paper

Authors

1 1. Department of Economics, Faculty of Administrative Sciences and Economics, Vali-e-Asr University of Rafsanjan, Rafsanjan, Iran.

2 Department of Mathematics, Faculty of Mathematics, Vali-e-Asr University of Rafsanjan, Rafsanjan, Iran.

Abstract

Macroeconomic policies highlight the importance of coordination between the government and the central bank in ensuring the effective attainment of their desired goals. Economic literature shows that cooperation between these key players and policymakers can yield improved outcomes concerning economic growth and stable inflation in contrast to situations where they act independently. A crucial challenge these players may face in this game is the uncertainty surrounding the fiscal authority's capacity to secure its intended budgetary targets, prompting the policymakers to exercise more caution when responding to policy measures. The present study, therefore, aims to analyze the best response function, Pareto equilibrium, and loss function of the government and the central bank in cooperative games. The findings indicate that within a cooperative framework, the monetary authority's response function exhibits contradictory tendencies due to increased policy interest rates, as demonstrated by the simulation results in the game. Additionally, within a cooperative scenario, the Pareto equilibrium is established at a lower level than the Nash equilibrium considering inflation stability and economic growth. Furthermore, within the cooperative context, the government undergoes a lower loss function and budget deficit, while the central bank experiences a higher loss function in the non-cooperative game. However, with a decrease in the economic uncertainty level, the equilibrium output level increases in cooperative and non-cooperative scenarios. Ultimately, the current study offers a set of policy recommendations based on the findings.

Keywords

Main Subjects

References

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History

  • Receive Date: 25 March 2024
  • Revise Date: 12 March 2025
  • Accept Date: 04 May 2025

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