A Role for an International Institution: A One-Shot Game-Theoretic Approach

In this paper we use a two-country model of flexible exchange rates to analyse strategic interdependence. Values for the policy instruments are selected from discrete sets, increasing the likelihood of a non-unique Nash equilibrium. Communication between the policy makers becomes very important; we define international institutions as communication devices, since their mission in the context of our model (we are in a one-shot game) is indeed the exchange of some information, either policy proposals or recommendations. We discuss two such devices: direct communication (for instance, a telephone line), and communication through a mediator (an international parliament) that makes policy recommendations to both countries, which are not necessarily followed. The conclusion is that these devices may increase actual or expected welfare levels and ease agreement between decision makers, even in a world where Nash equilibria are efficient.