Central Government Credibility and Monetary Expansion: a Game Theoretic Model

Abstract

This chapter formalizes the central-local monetary game, discussed in the previous chapter, in a formal model. This model shows how China’s inflation over the past decade may be a consequence of the decentralized financial system in which the central bank determines the credit ceilings and the local banks allocate credits between different projects. The institutional factors that contribute to inflation will be identified and particular attention will be given to the role played by the central bank’s lack of commitment to its credit policy.