Monetary and Fiscal Interaction between Europe and America: Case B

Abstract

This chapter deals with 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 targets of the European government are zero unemployment and a zero structural deficit in Europe. And the targets of the American government are zero unemployment and a zero structural deficit in America. The model of unemployment, inflation, and the structural deficit can be characterized by a system of six equations:

$$ u_{1} = A_{1}- M_{1} + 0.5M_{2} - G_{1} + 0.5G_{2} $$

(1)

$$ u_{2} = A_{2}- M_{2} + 0.5M_{1} - G_{2} + 0.5G_{1} $$

(2)

$$ \pi_{1} = B_{1} + M_{1} - 0.5M_{2} + G_{1}-0.5G_{2} $$

(3)

$$ \pi_{2} = B_{2} + M_{2} - 0.5M_{1} + G_{2}-0.5G_{1} $$

(4)

$$ s_{1}=G_{1}-T_{1} $$

(5)

$$ s_{2}=G_{2}-T_{2} $$

(6)

The targets of the European central bank are zero inflation and zero unemployment in Europe. The instrument of the European central bank is European money supply. There are two targets but only one instrument, so what is needed is a loss function.