State Manipulation and Asymptotic Inefficiency in a Dynamic Model of Monetary Policy*

Paper number: 96/05

Paper date: March 1996

Year: 1996

Paper Category: Discussion Paper


Henrick Jensen
University of Copenhagen**

Ben Lockwood
University of Exeter***


A simple folk theorem of repeated games states that Pareto-efficient outcomes can be achieved in a perfect equilibrium where deviations are punished by a reversion to Nash equilibrium of the associated stage game (Nash threats equilibrium), provided that players are sufficiently patient. In a dynamic version of a well-known monetary policy game we show that such asymptotic efficiency may not be possible, as the presence of a state variable introduces the possibility of state manipulation. Moreover, the lowest inflation rate in Nash threats equilibrium may be increasing as players become more patient.

First version: October 1994
Revised: September 1995
Second version: March 1996

JEL Classification Nos: C73, E52
Keywords: State manipulation, Asymptotic inefficiency, Monetary policy, Unemployment persistence, Dynamic games

Corresponding Author: Ben Lockwood, ***Department of Economics, University of Exeter, Amory Building, Rennes Drive, Exeter EX4 4RJ,Great Britain, tel:(44) 1392 263219, fax: (44) 1392 263242, email:


*We have benefitted from comments by Ken Binmore and Christian Schultz. All responsibility for the following, however, is ours. **Institute of Economics, University of Copenhagen, Studiestraede 6, DK-1455 Copenhagen K, Denmark