Topics in Economic Analysis – Mathematical solutions to macroeconomic policy.**

Mark: 1:1

Conceptualising the relationship between the government and central bank, hence fiscal and monetary policy respectively, the assignment uses mathematics and cold hard logic to identify how players would set fiscal and monetary policy under different circumstances. The assignment looks that the relationship between fiscal and monetary policy through utility payoffs for the government and central bank respectively in a game theory context. While on first glance we see that the outcome for government and central bank utility do rest on each others actions due to the complementary nature of fiscal and monetary policy, we attempt to dig deeper into the true extent of their relationship.

Section one comments on utility functions for the government and central bank. Section two shows how policy is set in a “cournout duopoly” context, where both parties set fiscal and monetary policy at the same time. Section three shows policy making in a “stakelberg” context, where the government chooses fiscal policy first, allowing the central bank to choose monetary policy at their best response to the governments level of fiscal policy. Section four identifies the outcome if both players co-operated in their approach to policy setting. While section five explains the rationale of using game theory to explain the conduct of monetary policy by an independent central bank.