Discussion Paper Series 2017-E-3

Guiding the Economy Toward the Target Inflation Rate:An Evolutionary Game Theory Approach

Yasushi Asako, Tatsushi Okuda

Under what condition is the target inflation rate attainable even after the monetary policy rate hits its lower bound? This study examines the question using a dynamic model based on evolutionary game theory. In the model, entrepreneurs and workers iteratively play a stage game to make investment decisions. In the presence of complementarity between entrepreneurs' and workers' investments, two long-run equilibria exist: all players invest or no player invests. The study shows two conditions for successfully guiding the economy toward the long-run equilibrium that all players invest at the target inflation rate. First, the type of entrepreneurs' investments needs to be demand-creating innovation rather than cost-reducing innovation. Second, the proportions of entrepreneurs and workers currently investing must be sufficiently large.

Keywords: Target inflation rate; Evolutionary game; Best-response dynamics; Perfect-foresight dynamics; Multiple long-run equilibria; Capital-skill complementarity; Demand-creating innovation

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

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