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Bargaining for Costs of Convergence in Exchange Rate Mechanism II: A Rubinstein Threat Game
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Bargaining for Costs of Convergence in
Exchange Rate Mechanism II: A Rubinstein
Threat Game
Christian H. Fahrholz
∗
October 19, 2004
Abstract
The Exchange-Rate Mechanism II (ERM II) is one of the Maastricht nominal con-
vergence criteria, that Central Eastern European Countries (CEECs) have to complywith before they are admitted to the European Monetary Union (EMU). However, EMU-accession is not a ‘free lunch’ but entails so-called costs of convergence. In accordance withthe ‘Treaty establishing the European Community’ CEECs have incurred these costs.Starting from the point of view that these new European Union (EU) members are infact credibly committed to joining the EMU for political reasons—i.e. ensuring politicalstability in CEECs—it is demonstrated that CEECs are enabled to pass some costs of con-vergence on to current EMU-members. The CEECs’ leverage is brought about throughexchange-rate policy: CEECs will under identifiable conditions threaten to halt the en-tire enlargement process by putting their exchange-rate regimes and, as a result, politicalstability at risk. The according stance of exchange-rate policy is denoted as a ’threaten-thy-neighbour’-strategy. If a CEEC’s brinkmanship constitutes a deterrent threat, bothparties will negotiate the distribution of these costs of convergence.
In line with this rationale, the entire process of transition, in reference to the phase of
ERM II, can be modelled as a two-stage threat game, which is completed by a Rubinstein-bargaining solution (RBS).
KEYWORDS: Threat game, Rubinstein, EMU, exchange-rate policy.
Prepared for delivery at the 2004 Annual Meeting of the American Political
Science Association, September 2 - September 5, 2004. Copyright by the
American Political Science Association.
∗
Department of Political and Social Sciences, Freie Universit¨at Berlin, Germany; E-
mail: ## email not listed ##. This research gained from my collaboration withinthe international research project ‘The Eastward Enlargement of the Eurozone’ (Ezone-plus) funded by the Fifth Framework Programme of the EU-Commission. This projectwas carried out at the Jean Monnet Centre of Excellence, financial support is gratefullyacknowledged. I thank Prof. Michael Bolle and his colleagues for helpful comments.
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| | Authors: Fahrholz, Christian. |
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Bargaining for Costs of Convergence in
Exchange Rate Mechanism II: A Rubinstein
Threat Game
Christian H. Fahrholz
∗
October 19, 2004
Abstract
The Exchange-Rate Mechanism II (ERM II) is one of the Maastricht nominal con-
vergence criteria, that Central Eastern European Countries (CEECs) have to comply
with before they are admitted to the European Monetary Union (EMU). However, EMU-
accession is not a ‘free lunch’ but entails so-called costs of convergence. In accordance with
the ‘Treaty establishing the European Community’ CEECs have incurred these costs.
Starting from the point of view that these new European Union (EU) members are in
fact credibly committed to joining the EMU for political reasons—i.e. ensuring political
stability in CEECs—it is demonstrated that CEECs are enabled to pass some costs of con-
vergence on to current EMU-members. The CEECs’ leverage is brought about through
exchange-rate policy: CEECs will under identifiable conditions threaten to halt the en-
tire enlargement process by putting their exchange-rate regimes and, as a result, political
stability at risk. The according stance of exchange-rate policy is denoted as a ’threaten-
thy-neighbour’-strategy. If a CEEC’s brinkmanship constitutes a deterrent threat, both
parties will negotiate the distribution of these costs of convergence.
In line with this rationale, the entire process of transition, in reference to the phase of
ERM II, can be modelled as a two-stage threat game, which is completed by a Rubinstein-
bargaining solution (RBS).
KEYWORDS: Threat game, Rubinstein, EMU, exchange-rate policy.
Prepared for delivery at the 2004 Annual Meeting of the American Political
Science Association, September 2 - September 5, 2004. Copyright by the
American Political Science Association.
∗
Department of Political and Social Sciences, Freie Universit¨at Berlin, Germany; E-
mail: ## email not listed ##. This research gained from my collaboration within
the international research project ‘The Eastward Enlargement of the Eurozone’ (Ezone-
plus) funded by the Fifth Framework Programme of the EU-Commission. This project
was carried out at the Jean Monnet Centre of Excellence, financial support is gratefully
acknowledged. I thank Prof. Michael Bolle and his colleagues for helpful comments.
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