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Edited by Andrew W. Mullineux and Victor Murinde
23. The institutional design of central banks Falko Fecht and Gerhard Illing 1 INTRODUCTION The question of how monetary institutions should be designed has attracted considerable attention during the past years. In the context of the Maastricht Treaty, there has been a plethora of papers on the design of the European Central Bank (ECB); the breakdown of the rouble zone created a strong demand for policy advice about what kind of monetary institutions should be adapted in Eastern European countries; ﬁnally, after the breakdown of stability of money demand in many countries, there was a need to redesign monetary policy instruments. For those searching for theoretical foundations of policy advice, game theory has been a popular candidate for obvious reasons: a speciﬁc branch in game theory is concerned with the issue of mechanism design (that is, the search for adequate rules). The mechanism design approach has been extremely successful in the theory of industrial organization, yielding important insights into issues such as the optimal regulation of ﬁrms under asymmetric information. One of the most spectacular applications was the design of auctions for selling radio waves by the federal government in the US. It seems natural to try to apply these methods also to monetary policy, and so it is not surprising that game-theoretic models play a major role in the present debate on the design of monetary policy. Indeed, these models provide helpful insights into what rules of the game monetary policy should follow. During the past years, there...
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