MACROECONOMIC POLICY STRATEGIES IN A MONETARY UNION: SIMULATIONS WITH A DYNAMIC-GAME MODEL Dmitri Blueschke Viktoria Blueschke-Nikolaeva Reinhard Neck University of Klagenfurt Department of Economics Universitätsstrasse 65-67, 9020 Klagenfurt, Austria E-mail: reinhard.neck@aau.at KEYWORDS Dynamic game, numerical simulations, macroeconomic model, monetary union, public debt, coalitions. ABSTRACT We analyze alternative strategies of monetary and fiscal policies in a monetary union model using a small macroeconomic model and by running numerical simulations in the framework of a dynamic game. Several coalitions are investigated between governments of the member countries and the common central bank. We show that only a coalition between all governments and the central bank is efficient while a fiscal union or other partial coalitions can be counterproductive. INTRODUCTION A series of crises shook the euro area (EA) over the last few years: the Great Recession (the financial crisis 2008– 2010), the European sovereign debt crisis, the COVID- 19 crisis, and the Ukraine war (energy price) crisis. The EA was particularly vulnerable during the sovereign debt crisis in view of the heterogeneity of its economies; moreover, the European Central Bank (ECB) is responsible for monetary policy for all participating countries despite the asymmetries between them. For policy makers concerned with monetary and fiscal policy for macroeconomic objectives such as economic growth, employment, price stability, and the sustainability of public finances, it is highly desirable to be given some guidance as to how they should design their policies to reach their objectives as well as possible. In this paper, we examine the optimal design of fiscal and monetary policy in a monetary union like the EA in the presence of shocks similar to the series of crises over the last few years using numerical simulations of dynamic games between policy makers. Dynamic game theory is an appropriate tool to analyze the dynamics within a monetary union and enables us to consider the strategic interactions of heterogeneous players. Analytical solutions of dynamic games are available only in extremely restrictive circumstances; hence numerical solutions are called for. Following (Michalak et al. 2008), (Blueschke and Neck 2011), (Anastasiou et al. 2019), and (Blueschke and Neck 2018), among others, we study interactions between monetary and fiscal players for a macroeconomic model of a monetary union with three fiscal players (representing blocks of countries) and a common central bank to capture some specific asymmetries between the EA countries. Of course, the EA consists of more countries but considering interactions between all of them would be rather cumbersome without adding much to the question we investigate here. A more restrictive assumption we have to make is the requirement that coalitions between the countries remain the same over the entire horizon of the dynamic game. Our results in terms of the EA should therefore be interpreted with care. The structure of the paper is as follows: The next section sketches the basic approach of dynamic game theory and our solution algorithm OPTGAME. The following section describes the model of the monetary union used in the analysis as well as the objective functions of the policy makers and specifies the numerical values of the parameters. It also shows the exogenous shocks and their calibration. The results of game experiments with five scenarios are presented and interpreted in the next section. In the next section, the sensitivity of the results is examined with respect to the weights of the countries in the monetary union. The last section concludes. THE DYNAMIC GAME FRAMEWORK Here we apply the dynamic game framework (see, e.g., (Basar and Olsder 1999), (Basar and Zaccour 2018)) in order to analyze coalition strategies between the countries in a monetary union facing different shocks. The economies under consideration are described by a dynamic system of nonlinear difference equations in state-space form: ݔ ௧ ൌ ሺ ݔ ௧ଵ ǡ ݔ ௧ ǡ ݑ ௧ ଵ ǡǥǡ ݑ ௧ ே ǡ ݖ ௧ ሻǡ ݔ ଴ ൌ ݔ ଴ തതത. (1) Here ݔ ௧ is an (ൈͳ) vector of state variables and ݑ ௧ ௜ is an ( ௜ ൈ ͳ) vector of individual control variables of player  ( ൌ ͳǡ ǥ ǡ ) having  ௜ variables at their disposal. ݖ ௧ is a vector of non-controlled exogenous variables including exogenous shocks, ݐൌͳǡǥǡ. The problem is formulated in the so-called dynamic tracking game form where each player minimizes an Communications of the ECMS, Volume 37, Issue 1, Proceedings, ©ECMS Enrico Vicario, Romeo Bandinelli, Virginia Fani, Michele Mastroianni (Editors) 2023 ISBN: 978-3-937436-80-7/978-3-937436-79-1 (CD) ISSN 2522-2414