DP1297 | Reciprocity and Inflation in Federal Monetary Unions


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This paper presents a model of monetary policy-making in a federal monetary union. Central bank council members are representatives from the member states. In a repeated-game context, council members have an incentive to engage in strategic voting, trading political favours between each other. The paper shows that a reciprocity-equilibrium exists in the repeated bargaining game. Reciprocity induces a positive inflation bias and nominal fluctuations in the monetary union.