Fiscal Policy in Germany A

The monetary union consists of two countries, say Germany and France. The member countries are the same size and have the same behavioural functions. An increase in German government purchases lowers unemployment in Germany. On the other hand, it raises producer inflation there. For ease of exposition we assume that fiscal policy in one of the countries has no effect on unemployment or producer inflation in the other country.

The model of unemployment and inflation can be represented by a system of two equations:

$${\rm u}_1 = {\rm A}_1 - {\rm G}_1$$

((1))

$${\rm \pi }_1 = {\rm B}_1 + {\rm G}_1$$

((2))

Here u₁ denotes the rate of unemployment in Germany, π₁ is the rate of inflation in Germany, G₁ is German government purchases, A₁ is some other factors bearing on the rate of unemployment in Germany, and B1 is some other factors bearing on the rate of inflation in Germany. The endogenous variables are the rate of unemployment and the rate of inflation in Germany.