A Nash Threat Game of Passing Through Exchange Rate Mechanism II

Following entrance into the European Union, Central Eastern European Countries (CEECs) are expected to join the European Monetary Union (EMU). These countries may incur considerable costs over the course of their passing through the required Exchange Rate Mechanism II (ERM-II). However, with enough bargaining leverage, CEECs may be able to pass some of these costs on to current EMU members. In turn, a CEEC's leverage depends on its ability to wield successful brinkmanship via an exchange-rate policy characterized by a “threaten-thy-neighbor” strategy. A two-stage Nash-threat game captures the essentials of the CEECs' phase of ERM-II pass-through.