Interaction between Central Bank and Government A

An increase in European money supply lowers unemployment in Europe. On the other hand, it raises inflation there. However, it has no effect on the structural deficit. Correspondingly, an increase in European government purchases lowers unemployment in Europe. On the other hand, it raises inflation there. And what is more, it raises the structural deficit. The primary target of the European central bank is zero inflation in Europe. By contrast, the primary targets of the European government are zero unemployment and a zero structural deficit there.

The model of unemployment, inflation, and the structural deficit can be represented by a system of three equations:

$${\rm u} = {\rm A} - {\rm M} - {\rm G}$$

((1))

$${\rm \pi } = {\rm B} + {\rm M} + {\rm G}$$

((2))

$${\rm s} = {\rm G} - {\rm T}$$

((3))

Here u denotes the rate of unemployment in Europe, π is the rate of inflation in Europe, s is the structural deficit ratio in Europe, M is European money supply, G is European government purchases, T is European tax revenue at full-employment output, G−T is the structural deficit in Europe, A is some other factors bearing on the rate of unemployment in Europe, and B is some other factors bearing on the rate of inflation in Europe. The endogenous variables are the rate of unemployment, the rate of inflation, and the structural deficit ratio.