Dynamic Game Theory and Models of International Macroeconomic Policy REINHARD NECK Department of Economics Klagenfurt University Universitaetsstrasse 65-67, A-9020 Klagenfurt AUSTRIA reinhard.neck@uni-klu.ac.at http://www.uni-klu.ac.at/vwl Abstract: - In this paper, we provide a survey of dynamic game theory with special emphasis on past and possi- ble future applications to problems of international economic policy making, where we concentrate on macroe- conomic and stabilization policy problems. First, the paper gives a brief introduction to the theory of dynamic games. Next, we show by example that dynamic game theory can provide insights into problems of macroeco- nomics, in particular international stabilization policies in the context of a monetary union. Key-Words: - Dynamic games, optimization, game theory, monetary policy, fiscal policy, macroeconomics, international economics, cooperation. 1 Introduction Game theory since its beginning [14] has been de- veloped in constant cooperation by mathematicians and economists. Most economic models for which game theory has proved to be the appropriate tool of analysis belong to microeconomics, in particular oligopoly markets, where a “small” number of com- peting firms is engaged in a strategic interaction. However, more recently it has been recognized that game theory can also be useful when studying the interactions between policy-makers of the same or of different countries when they have different prefe- rences concerning their target variables. These mod- els are mostly macroeconomic ones, depicting the relations between economic aggregates such as, for instance, output (GDP), the price level, employment, etc. In this paper, we give a brief history of and intro- duction into dynamic game theory (Section 2) and sketch some of its applications in international ma- croeconomics (Section 3). Section 4 concludes. 2 An Introduction to Dynamic Game Theory The theory of dynamic games is based on concepts rooted in dynamic optimization and optimum control theory on the one hand and static game theory on the other. For a game, the presence of at least two deci- sion-makers with different objectives is constitutive. Fig. 1 gives a schematic picture of the genesis of dynamic game theory. Fig. 1. Genesis of dynamic games Formulating a dynamic game requires the following ingredients (see [1], [3], [5], [9], for more details): 1. A set of players (decision-makers, agents): { } ⊂ ∈ = N N i n , ,..., 2 , 1 Í. dynamic systems theory optimum control theory dynamic programming dynamic 1-agent optimization static optimization (“programming“) static game theory team theory dynamic game theory decentralized control theory differential games difference games