In discussion paper No1297, Research Fellow Jürgen von Hagen presents a model of monetary policy-making in a federal monetary union. Central bank council members are concerned with inflation in the union, but they also wish to pursue a policy of easy money when their home governments face elections. The question posed in this paper asks whether central bank council members will engage in vote-trading in such a setting. That is, whether council members will be willing to support their fellow members' demand for easy money in years when their own countries do not hold elections. The incentive to engage in vote trading comes from the anticipation that the central bank council will support a member's demand for easy money in the future if that member supports a similar demand today.

The paper shows that such reciprocity-equilibria do exist in the repeated bargaining game that is played on the central bank council. In equilibrium, vote-trading induces a positive inflation bias and nominal and real fluctuations. A number of interesting characterizations arise from the reciprocity equilibrium. First, the more `conservative' the central bank council members, i.e. the less they discount the future, the larger the inflation bias. Second, shortening the council members' appointment period tends to reduce the inflation bias. These results contradict the findings from single-shot monetary policy games or repeated games where the central bank council is treated as a unitary actor. Third, lengthening the election cycle of the member states reduces the inflation bias, as does the appointment of council members representing the aggregate union interest as opposed to the regional interests of the member states.