Fiscal Interaction between Europe and America

Abstract

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 government purchases lowers European unemployment. On the other hand, it raises European inflation. And what is more, it raises the European structural deficit. Correspondingly, an increase in American government purchases lowers American unemployment. On the other hand, it raises American inflation. And what is more, it raises the American structural deficit. 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.