Strategic Aspects of International Lending and Borrowing: A Two-Country Dynamic Game Model

Abstract

This paper is consideration of strategic aspects of national saving policies in a game theory setting. In pure exchange economy involving two countries, each government chooses a future time path of the national consumption-wealth ratio in order to maximize its citizens' utility. When private time preference rates of two countries are different, the government of the country with the lower time preference rate has an incentive to slow down the national asset accumulation. The government of the higher time preference rate country has an incentive to slow down the national asset reduction. In Cournot-Nash equilibria of this dynamic game, international capital flows are depressed as compared with competitive equilibria, which are Pareto-optimal. It is shown that the governments achieve the Cournot-Nash equilibrium path of consumption-wealth ratio using a set of taxes and subsidies. A large country intervenes into the market more than a small one. In this sense, a large country exploits a small one. Dynamics of world interest rates are also analyzed.