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FW: Monetary and Fiscal Strategies in the World Economy_4

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FW: Monetary and Fiscal Strategies in the World Economy_4

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  1. 122 Fiscal Interaction between Europe and America 2. Some Numerical Examples For easy reference, the basic model is reproduced here: u1 = A1 − G1 − 0.5G 2 (1) u 2 = A 2 − G 2 − 0.5G1 (2) π1 = B1 + G1 + 0.5G 2 (3) π2 = B2 + G 2 + 0.5G1 (4) s1 = G1 − T1 (5) s 2 = G 2 − T2 (6) And the Nash equilibrium can be described by two equations: 15G1 = 8A1 − 2A 2 + 6T (7) 15G 2 = 8A 2 − 2A1 + 6T (8) It proves useful to study six distinct cases: - a demand shock in Europe - a supply shock in Europe - a mixed shock in Europe - another mixed shock in Europe - a common demand shock - a common supply shock. 1) A demand shock in Europe. In each of the regions, let initial unemployment be zero, let initial inflation be zero, and let the initial structural deficit be zero as well. Step one refers to a decline in the demand for European goods. In terms of the model there is an increase in A1 of 3 units and a decline in B1 of equally 3 units. Step two refers to the outside lag. Unemployment in Europe goes from zero to 3 percent. Unemployment in America stays at zero percent. Inflation in Europe goes from zero to – 3 percent. Inflation in America
  2. 2. Some Numerical Examples 123 stays at zero percent. The structural deficit in Europe stays at zero percent, as does the structural deficit in America. Step three refers to the policy response. According to the Nash equilibrium there is an increase in European government purchases of 1.6 units and a reduction in American government purchases of 0.4 units. Step four refers to the outside lag. Unemployment in Europe goes from 3 to 1.6 percent. Unemployment in America goes from zero to – 0.4 percent. Inflation in Europe goes from – 3 to – 1.6 percent. Inflation in America goes from zero to 0.4 percent. The structural deficit in Europe goes from zero to 1.6 percent. And the structural deficit in America goes from zero to – 0.4 percent. Table 5.1 presents a synopsis. Table 5.1 Fiscal Interaction between Europe and America A Demand Shock in Europe Europe America Unemployment 0 Unemployment 0 Inflation 0 Inflation 0 Structural Deficit 0 Structural Deficit 0 3 Shock in A1 −3 Shock in B1 Unemployment 3 Unemployment 0 −3 Inflation Inflation 0 Change in Govt Purchases − 0.4 Change in Govt Purchases 1.6 − 0.4 Unemployment 1.6 Unemployment − 1.6 Inflation Inflation 0.4 − 0.4 Structural Deficit 1.6 Structural Deficit
  3. 124 Fiscal Interaction between Europe and America First consider the effects on Europe. As a result, given a demand shock in Europe, fiscal interaction lowers unemployment and deflation in Europe. On the other hand, it raises the structural deficit there. Second consider the effects on America. As a result, fiscal interaction produces overemployment and inflation in America. And what is more, it produces a structural surplus there. The loss functions of the European government and the American government are respectively: 2 2 L1 = u1 + s1 (9) u2 2 L2 = + s2 (10) 2 The initial loss of the European government is zero, as is the initial loss of the American government. The demand shock in Europe causes a loss to the European government of 9 units and a loss to the American government of zero units. Then fiscal interaction reduces the loss of the European government from 9 to 5.12 units. On the other hand, fiscal interaction increases the loss of the American government from zero to 0.32 units. 2) A supply shock in Europe. In each of the regions let initial unemployment be zero, let initial inflation be zero, and let the initial structural deficit be zero as well. Step one refers to the supply shock in Europe. In terms of the model there is an increase in B1 of 3 units and an increase in A1 of equally 3 units. Step two refers to the outside lag. Inflation in Europe goes from zero to 3 percent. Inflation in America stays at zero percent. Unemployment in Europe goes from zero to 3 percent. And unemployment in America stays at zero percent. Step three refers to the policy response. According to the Nash equilibrium there is an increase in European government purchases of 1.6 units and a reduction in American government purchases of 0.4 units. Step four refers to the outside lag. Unemployment in Europe goes from 3 to 1.6 percent. Unemployment in America goes from zero to – 0.4 percent. Inflation in Europe goes from 3 to 4.4 percent. Inflation in America goes from zero to 0.4 percent. The structural deficit in Europe goes from zero to 1.6 percent. And the structural deficit in America goes from zero to – 0.4 percent. Table 5.2 gives an overview.
  4. 2. Some Numerical Examples 125 Table 5.2 Fiscal Interaction between Europe and America A Supply Shock in Europe Europe America Unemployment 0 Unemployment 0 Inflation 0 Inflation 0 Structural Deficit 0 Structural Deficit 0 3 Shock in A1 3 Shock in B1 Unemployment 3 Unemployment 0 Inflation 3 Inflation 0 Change in Govt Purchases − 0.4 Change in Govt Purchases 1.6 − 0.4 Unemployment 1.6 Unemployment Inflation 4.4 Inflation 0.4 − 0.4 Structural Deficit 1.6 Structural Deficit First consider the effects on Europe. As a result, given a supply shock in Europe, fiscal interaction lowers unemployment in Europe. On the other hand, it raises the structural deficit there. And what is more, as a side effect, it raises inflation. Second consider the effects on America. As a result, fiscal interaction produces overemployment and inflation in America. And what is more, it produces a structural surplus there. The initial loss of each government is zero. The supply shock in Europe causes a loss to the European government of 9 units and a loss to the American government of zero units. Then fiscal interaction reduces the loss of the European government from 9 to 5.12 units. On the other hand, it increases the loss of the American government from zero to 0.32 units. 3) A mixed shock in Europe. In each of the regions, let initial unemployment be zero, let initial inflation be zero, and let the initial structural deficit be zero as well. Step one refers to the mixed shock in Europe. In terms of the model there is
  5. 126 Fiscal Interaction between Europe and America an increase in A1 of 6 units. Step two refers to the outside lag. Unemployment in Europe goes from zero to 6 percent. Unemployment in America stays at zero percent. Inflation in Europe stays at zero percent, as does inflation in America. Step three refers to the policy response. According to the Nash equilibrium there is an increase in European government purchases of 3.2 units and a reduction in American government purchases of 0.8 units. Step four refers to the outside lag. Unemployment in Europe goes from 6 to 3.2 percent. Unemployment in America goes from zero to – 0.8 percent. Inflation in Europe goes from zero to 2.8 percent. Inflation in America goes from zero to 0.8 percent. The structural deficit in Europe goes from zero to 3.2 percent. And the structural deficit in America goes from zero to – 0.8 percent. For a synopsis see Table 5.3. Table 5.3 Fiscal Interaction between Europe and America A Mixed Shock in Europe Europe America Unemployment 0 Unemployment 0 Inflation 0 Inflation 0 Structural Deficit 0 Structural Deficit 0 6 Shock in A1 0 Shock in B1 Unemployment 6 Unemployment 0 Inflation 0 Inflation 0 Change in Govt Purchases − 0.8 Change in Govt Purchases 3.2 − 0.8 Unemployment 3.2 Unemployment Inflation 2.8 Inflation 0.8 − 0.8 Structural Deficit 3.2 Structural Deficit
  6. 2. Some Numerical Examples 127 First consider the effects on Europe. As a result, given a mixed shock in Europe, fiscal interaction lowers unemployment in Europe. On the other hand, it raises the structural deficit there. And what is more, it raises inflation. Second consider the effects on America. As a result, fiscal interaction produces overemployment and inflation in America. And what is more, it produces a structural surplus there. The initial loss of each government is zero. The mixed shock in Europe causes a loss to the European government of 36 units and a loss to the American government of zero units. Then fiscal interaction reduces the loss of the European government from 36 to 20.48 units. On the other hand, it increases the loss of the American government from zero to 1.28 units. 4) Another mixed shock in Europe. In each of the regions, let initial unemployment be zero, let initial inflation be zero, and let the initial structural deficit be zero as well. Step one refers to the mixed shock in Europe. In terms of the model there is an increase in B1 of 6 units. Step two refers to the outside lag. Inflation in Europe goes from zero to 6 percent. Inflation in America stays at zero percent. Unemployment in Europe stays at zero percent, as does unemployment in America. Step three refers to the policy response. According to the Nash equilibrium there is no change in European government purchases, nor is there in American government purchases. Step four refers to the outside lag. Inflation in Europe stays at 6 percent. Inflation in America stays at zero percent. Unemployment in Europe stays at zero percent, as does unemployment in America. The structural deficit in Europe stays at zero percent, as does the structural deficit in America. For an overview see Table 5.4. As a result, given another mixed shock in Europe, fiscal interaction produces zero unemployment and a zero structural deficit in each of the regions. The mixed shock in Europe does not cause any loss to the European government or American government.
  7. 128 Fiscal Interaction between Europe and America Table 5.4 Fiscal Interaction between Europe and America Another Mixed Shock in Europe Europe America Unemployment 0 Unemployment 0 Inflation 0 Inflation 0 Structural Deficit 0 Structural Deficit 0 0 Shock in A1 6 Shock in B1 Unemployment 0 Unemployment 0 Inflation 6 Inflation 0 Change in Govt Purchases 0 Change in Govt Purchases 0 Unemployment 0 Unemployment 0 Inflation 6 Inflation 0 Structural Deficit 0 Structural Deficit 0 5) A common demand shock. In each of the regions, let initial unemployment be zero, let initial inflation be zero, and let the initial structural deficit be zero as well. Step one refers to a decline in the demand for European and American goods. In terms of the model there is an increase in A1 of 3 units, a decline in B1 of 3 units, an increase in A 2 of 3 units, and a decline in B 2 of 3 units. Step two refers to the outside lag. Unemployment in Europe goes from zero to 3 percent, as does unemployment in America. Inflation in Europe goes from zero to – 3 percent, as does inflation in America. Step three refers to the policy response. According to the Nash equilibrium there is an increase in European government purchases and American government purchases of 1.2 units each. Step four refers to the outside lag. Unemployment in Europe goes from 3 to 1.2 percent, as does unemployment in America. Inflation in Europe goes from – 3 to – 1.2 percent, as does inflation in
  8. 2. Some Numerical Examples 129 America. The structural deficit in Europe goes from zero to 1.2 percent, as does the structural deficit in America. Table 5.5 presents a synopsis. As a result, given a common demand shock, fiscal interaction lowers unemployment and deflation in each of the regions. On the other hand, it raises the structural deficit there. The initial loss of each government is zero. The common demand shock causes a loss to the European government of 9 units and a loss to the American government of equally 9 units. Then fiscal interaction reduces the loss of the European government from 9 to 2.88 units. Correspondingly, it reduces the loss of the American government from 9 to 2.88 units. Table 5.5 Fiscal Interaction between Europe and America A Common Demand Shock Europe America Unemployment 0 Unemployment 0 Inflation 0 Inflation 0 Structural Deficit 0 Structural Deficit 0 3 3 Shock in A1 Shock in A2 −3 −3 Shock in B1 Shock in B2 Unemployment 3 Unemployment 3 −3 −3 Inflation Inflation Change in Govt Purchases 1.2 Change in Govt Purchases 1.2 Unemployment 1.2 Unemployment 1.2 − 1.2 − 1.2 Inflation Inflation Structural Deficit 1.2 Structural Deficit 1.2
  9. 130 Fiscal Interaction between Europe and America 6) A common supply shock. In each of the regions, let initial unemployment be zero, let initial inflation be zero, and let the initial structural deficit be zero as well. Step one refers to the common supply shock. In terms of the model there is an increase in B1 of 3 units, as there is in A1 . And there is an increase in B 2 of 3 units, as there is in A 2 . Step two refers to the outside lag. Inflation in Europe goes from zero to 3 percent, as does inflation in America. Unemployment in Europe goes from zero to 3 percent, as does unemployment in America. Step three refers to the policy response. According to the Nash equilibrium there is an increase in European government purchases and American government purchases of 1.2 units each. Step four refers to the outside lag. Unemployment in Europe goes from 3 to 1.2 percent, as does unemployment in America. Inflation in Europe goes from 3 to 4.8 percent, as does inflation in America. The structural deficit in Europe goes from zero to 1.2 percent, as does the structural deficit in America. Table 5.6 gives an overview. As a result, given a common supply shock, fiscal interaction lowers unemployment in Europe and America. On the other hand, it raises the structural deficits there. And what is more, it raises inflation. The initial loss of each government is zero. The common supply shock causes a loss to the European government of 9 units and a loss to the American government of equally 9 units. Then fiscal interaction reduces the loss of the European government from 9 to 2.88 units. Correspondingly, it reduces the loss of the American government from 9 to 2.88 units. 7) Summary. Given a demand shock in Europe, fiscal interaction lowers unemployment and deflation in Europe. On the other hand, it raises the structural deficit there. Given a supply shock in Europe, fiscal interaction lowers unemployment in Europe. On the other hand, it raises the structural deficit there. And what is more, as a side effect, it raises inflation. Given a certain type of mixed shock in Europe, fiscal interaction produces zero unemployment and a zero structural deficit in each of the regions.
  10. 2. Some Numerical Examples 131 Table 5.6 Fiscal Interaction between Europe and America A Common Supply Shock Europe America Unemployment 0 Unemployment 0 Inflation 0 Inflation 0 Structural Deficit 0 Structural Deficit 0 3 3 Shock in A1 Shock in A2 3 3 Shock in B1 Shock in B2 Unemployment 3 Unemployment 3 Inflation 3 Inflation 3 Change in Govt Purchases 1.2 Change in Govt Purchases 1.2 Unemployment 1.2 Unemployment 1.2 Inflation 4.8 Inflation 4.8 Structural Deficit 1.2 Structural Deficit 1.2
  11. 132 Chapter 2 Fiscal Cooperation between Europe and America 1. The Model The model of unemployment, inflation, and the structural deficit can be characterized by a system of six equations: u1 = A1 − G1 − 0.5G 2 (1) u 2 = A 2 − G 2 − 0.5G1 (2) π1 = B1 + G1 + 0.5G 2 (3) π2 = B2 + G 2 + 0.5G1 (4) s1 = G1 − T1 (5) s 2 = G 2 − T2 (6) The policy makers are the European government and the American government. The targets of fiscal cooperation are zero unemployment and a zero structural deficit in each of the regions. The instruments of fiscal cooperation are European government purchases and American government purchases. There are four targets but only two instruments, so what is needed is a loss function. We assume that the European government and the American government agree on a common loss function: 2 2 2 2 L = u1 + u 2 + s1 + s 2 (7) L is the loss caused by unemployment and the structural deficit in each of the regions. We assume equal weights in the loss function. The specific target of fiscal cooperation is to minimize the loss, given the unemployment functions and the structural deficit functions. Taking account of equations (1), (2), (5) and (6), the loss function under fiscal cooperation can be written as follows: M. Carlberg, Monetary and Fiscal Strategies in the World Economy, 132 DOI 10.1007/978-3-642-10476-3_18, © Springer-Verlag Berlin Heidelberg 2010
  12. 1. The Model 133 L = (A1 − G1 − 0.5G 2 ) 2 + (A 2 − G 2 − 0.5G1 ) 2 (8) + (G1 − T 1 ) 2 + (G 2 − T 2 ) 2 Then the first-order conditions for a minimum loss are: 9G1 = 4A1 + 2A 2 + 4T1 − 4G 2 (9) 9G 2 = 4A 2 + 2A1 + 4T2 − 4G1 (10) Equation (9) shows the first-order condition with respect to European government purchases. And equation (10) shows the first-order condition with respect to American government purchases. The cooperative equilibrium is determined by the first-order conditions for a minimum loss. We assume T = T1 = T2 . The solution to this problem is as follows: 65G1 = 28A1 + 2A 2 + 20T (11) 65G 2 = 28A 2 + 2A1 + 20T (12) Equations (11) and (12) show the cooperative equilibrium of European government purchases and American government purchases. As a result there is a unique cooperative equilibrium. An increase in A1 causes an increase in both European government purchases and American government purchases. A unit increase in A1 causes an increase in European government purchases of 0.43 units and an increase in American government purchases of 0.03 units. Evidently, the cooperative equilibrium is different from the Nash equilibrium. Put another way, fiscal cooperation is different from fiscal interaction.
  13. 134 Fiscal Cooperation between Europe and America 2. Some Numerical Examples It proves useful to study two distinct cases: - a demand shock in Europe - a supply shock in Europe. 1) A demand shock in Europe. In each of the regions, let initial unemployment be zero, let initial inflation be zero, and let the initial structural deficit be zero as well. Step one refers to a decline in the demand for European goods. In terms of the model there is an increase in A1 of 3 units and a decline in B1 of equally 3 units. Step two refers to the outside lag. Unemployment in Europe goes from zero to 3 percent. Unemployment in America stays at zero percent. Inflation in Europe goes from zero to – 3 percent. Inflation in America stays at zero percent. The structural deficit in Europe stays at zero percent, as does the structural deficit in America. Step three refers to the policy response. What is needed, according to the model, is an increase in European government purchases of 1.29 units and an increase in American government purchases of 0.09 units. Step four refers to the outside lag. Unemployment in Europe goes from 3 to 1.66 percent. Unemployment in America goes from zero to – 0.74 percent. Inflation in Europe goes from – 3 to – 1.66 percent. Inflation in America goes from zero to 0.74 percent. The structural deficit in Europe goes from zero to 1.29 percent. And the structural deficit in America goes from zero to 0.09 percent. Table 5.7 presents a synopsis. First consider the effects on Europe. As a result, given a demand shock in Europe, fiscal cooperation lowers unemployment and deflation in Europe. On the other hand, it raises the structural deficit there. Second consider the effects on America. As a result, fiscal cooperation produces overemployment and inflation in America. And what is more, it produces a structural deficit there. The loss function under fiscal cooperation is: 2 2 2 2 L = u1 + u 2 + s1 + s 2 (1)
  14. 2. Some Numerical Examples 135 The initial loss is zero. The demand shock in Europe causes a loss of 9 units. Then fiscal cooperation brings the loss down to 4.99 units. Now compare fiscal cooperation with fiscal interaction. The loss under fiscal cooperation is 4.99 units. And the loss under fiscal interaction is 5.44 units. So, given a demand shock in Europe, fiscal cooperation seems to be superior to fiscal interaction. Table 5.7 Fiscal Cooperation between Europe and America A Demand Shock in Europe Europe America Unemployment 0 Unemployment 0 Inflation 0 Inflation 0 Structural Deficit 0 Structural Deficit 0 3 Shock in A1 −3 Shock in B1 Unemployment 3 Unemployment 0 −3 Inflation Inflation 0 Change in Govt Purchases 1.29 Change in Govt Purchases 0.09 − 0.74 Unemployment 1.66 Unemployment − 1.66 Inflation Inflation 0.74 Structural Deficit 1.29 Structural Deficit 0.09 2) A supply shock in Europe. In each of the regions let initial unemployment be zero, let initial inflation be zero, and let the initial structural deficit be zero as well. Step one refers to the supply shock in Europe. In terms of the model there is an increase in B1 of 3 units and an increase in A1 of equally 3 units. Step two refers to the outside lag. Inflation in Europe goes from zero to 3 percent. Inflation in America stays at zero percent. Unemployment in Europe goes from zero to 3 percent. And unemployment in America stays at zero percent.
  15. 136 Fiscal Cooperation between Europe and America Step three refers to the policy response. What is needed, according to the model, is an increase in European government purchases of 1.29 units and an increase in American government purchases of 0.09 units. Step four refers to the outside lag. Unemployment in Europe goes from 3 to 1.66 percent. Unemployment in America goes from zero to – 0.74 percent. Inflation in Europe goes from 3 to 4.34 percent. Inflation in America goes from zero to 0.74 percent. The structural deficit in Europe goes from zero to 1.29 percent. And the structural deficit in America goes from zero to 0.09 percent. Table 5.8 gives an overview. Table 5.8 Fiscal Cooperation between Europe and America A Supply Shock in Europe Europe America Unemployment 0 Unemployment 0 Inflation 0 Inflation 0 Structural Deficit 0 Structural Deficit 0 3 Shock in A1 3 Shock in B1 Unemployment 3 Unemployment 0 Inflation 3 Inflation 0 Change in Govt Purchases 1.29 Change in Govt Purchases 0.09 − 0.74 Unemployment 1.66 Unemployment Inflation 4.34 Inflation 0.74 Structural Deficit 1.29 Structural Deficit 0.09 First consider the effects on Europe. As a result, given supply shock in Europe, fiscal cooperation lowers unemployment in Europe. On the other hand, it
  16. 2. Some Numerical Examples 137 raises the structural deficit there. And what is more, as a side effect, it raises inflation. Second consider the effects on America. As a result, fiscal cooperation produces overemployment and inflation in America. And what is more, it produces a structural deficit there. The initial loss is zero. The supply shock in Europe causes a loss of 9 units. Then fiscal cooperation brings the loss down to 4.99 units. Now compare fiscal cooperation with fiscal interaction. The loss under fiscal cooperation is 4.99 units. And the loss under fiscal interaction is 5.44 units. So, given a supply shock in Europe, fiscal cooperation seems to be superior to fiscal interaction. 3) Summary. Given a demand shock in Europe, fiscal cooperation lowers unemployment in Europe. On the other hand, it raises the structural deficit there. Given a demand shock in Europe, fiscal cooperation is superior to fiscal interaction. And the same applies to a supply shock in Europe.
  17. Part Six Monetary and Fiscal Policies in Europe and America Absence of a Deficit Target
  18. 141 Chapter 1 Monetary and Fiscal Interaction between Europe and America The world economy consists of two monetary regions, say Europe and America. The monetary regions are the same size and have the same behavioural functions. An increase in European money supply lowers European unemploy- ment. On the other hand, it raises European inflation. Correspondingly, an increase in American money supply lowers American unemployment. On the other hand, it raises American inflation. An essential point is that monetary policy in Europe has spillover effects on America and vice versa. An increase in European money supply raises American unemployment and lowers American inflation. Similarly, an increase in American money supply raises European unemployment and lowers European inflation. An increase in European government purchases lowers European unemploy- ment. On the other hand, it raises European inflation. Correspondingly, an increase in American government purchases lowers American unemployment. On the other hand, it raises American inflation. An essential point is that fiscal policy in Europe has spillover effects on America and vice versa. An increase in European government purchases lowers American unemployment and raises American inflation. Similarly, an increase in American government purchases lowers European unemployment and raises European inflation. The model of unemployment and inflation can be represented by a system of four equations: u1 = A1 − M1 + 0.5M 2 − G1 − 0.5G 2 (1) u 2 = A 2 − M 2 + 0.5M1 − G 2 − 0.5G1 (2) π1 = B1 + M1 − 0.5M 2 + G1 + 0.5G 2 (3) π2 = B2 + M 2 − 0.5M1 + G 2 + 0.5G1 (4) M. Carlberg, Monetary and Fiscal Strategies in the World Economy, 141 DOI 10.1007/978-3-642-10476-3_19, © Springer-Verlag Berlin Heidelberg 2010
  19. 142 Monetary and Fiscal Interaction between Europe and America Here u1 denotes the rate of unemployment in Europe, u 2 is the rate of unemployment in America, π1 is the rate of inflation in Europe, π2 is the rate of inflation in America, M1 is European money supply, M 2 is American money supply, G1 is European government purchases, G 2 is American government purchases, A1 is some other factors bearing on the rate of unemployment in Europe, A 2 is some other factors bearing on the rate of unemployment in America, B1 is some other factors bearing on the rate of inflation in Europe, and B2 is some other factors bearing on the rate of inflation in America. The endogenous variables are the rate of unemployment in Europe, the rate of unemployment in America, the rate of inflation in Europe, and the rate of inflation in America. According to equation (1), European unemployment is a positive function of A1 , a negative function of European money supply, a positive function of American money supply, a negative function of European government purchases, and a negative function of American government purchases. According to equation (2), American unemployment is a positive function of A 2 , a negative function of American money supply, a positive function of European money supply, a negative function of American government purchases, and a negative function of European government purchases. According to equation (3), European inflation is a positive function of B1 , a positive function of European money supply, a negative function of American money supply, a positive function of European government purchases, and a positive function of American government purchases. According to equation (4), American inflation is a positive function of B2 , a positive function of American money supply, a negative function of European money supply, a positive function of American government purchases, and a positive function of European government purchases. According to the model, a unit increase in European money supply lowers European unemployment by 1 percentage point. On the other hand, it raises European inflation by 1 percentage point. And what is more, a unit increase in European money supply raises American unemployment by 0.5 percentage points and lowers American inflation by 0.5 percentage points. According to the model, a unit increase in European government purchases lowers European unemployment by 1 percentage point. On the other hand, it raises European
  20. Monetary and Fiscal Interaction between Europe and America 143 inflation by 1 percentage point. And what is more, a unit increase in European government purchases lowers American unemployment by 0.5 percentage points and raises American inflation by 0.5 percentage points. To illustrate this there are two numerical examples. First consider an increase in European money supply. For instance, let European unemployment be 2 percent, and let European inflation be 2 percent as well. Further, let American unemployment be 2 percent, and let American inflation be 2 percent as well. Now consider a unit increase in European money supply. Then European unemployment goes from 2 to 1 percent. On the other hand, European inflation goes from 2 to 3 percent. And what is more, American unemployment goes from 2 to 2.5 percent, and American inflation goes from 2 to 1.5 percent. Second consider an increase in European government purchases. For instance, let European unemployment be 2 percent, and let European inflation be 2 percent as well. Further, let American unemployment be 2 percent, and let American inflation be 2 percent as well. Now consider a unit increase in European government purchases. Then European unemployment goes from 2 to 1 percent. On the other hand, European inflation goes from 2 to 3 percent. And what is more, American unemployment goes from 2 to 1.5 percent, and American inflation goes from 2 to 2.5 percent. As to policy targets there are three distinct cases. In case A the target of the European central bank is zero inflation in Europe. The target of the American central bank is zero inflation in America. The target of the European government is zero unemployment in Europe. And the target of the American government is zero unemployment in America. In case B the targets of the European central bank are zero inflation and zero unemployment in Europe. The targets of the American central bank are zero inflation and zero unemployment in America. The target of the European government is zero unemployment in Europe. And the target of the American government is zero unemployment in America. In case C the target of the European central bank is zero inflation in Europe. The targets of the American central bank are zero inflation and zero unemployment in America. The target of the European government is zero unemployment in Europe. And the target of the American government is zero unemployment in America.
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