Monetary policy strategies in the world economy carlberg_4

88 Monetary Interaction between Europe and America: Case C 2) A common supply shock. In each of the regions, let initial unemployment be zero, and let initial inflation 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 B2 of 3 units, as there is in A2 . 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 a reduction in European money supply of 4 units and a reduction in American money supply of 2 units. Step four refers to the outside lag. Inflation in Europe goes from 3 to zero percent. Inflation in America stays at 3 percent. Unemployment in Europe goes from 3 to 6 percent. And unemployment in America stays at 3 percent. Table 3.16 gives an overview. Table 3.16 Monetary Interaction between Europe and America A Common Supply Shock Europe America Unemployment 0 Inflation 0 Shock in A1 3 Shock in B1 3 Unemployment 3 Inflation 3 Change in Money Supply − 4 Unemployment 6 Inflation 0 Unemployment 0 Inflation 0 Shock in A2 3 Shock in B2 3 Unemployment 3 Inflation 3 Change in Money Supply − 2 Unemployment 3 Inflation 3 2. Some Numerical Examples 89 First consider the effects on Europe. As a result, given a common supply shock, monetary interaction produces zero inflation in Europe. However, as a side effect, it raises unemployment there. Second consider the effects on America. As a result, monetary interaction has no effect on inflation and unemployment in America. The initial loss of each central bank is zero. The common supply shock causes a loss to the European central bank of 9 units and a loss to the American central bank of 18 units. Then monetary interaction reduces the loss of the European central bank from 9 to zero units. On the other hand, it keeps the loss of the American central bank at 18 units. 3) A common mixed shock. In each of the regions, let initial unemployment be zero, and let initial inflation be zero as well. Step one refers to the common mixed shock. In terms of the model there is an increase in B1 of 6 units and an increase in B2 of equally 6 units. Step two refers to the outside lag. Inflation in Europe goes from zero to 6 percent, as does inflation in America. 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 a reduction in European money supply of 10 units and a reduction in American money supply of 8 units. Step four refers to the outside lag. Inflation in Europe goes from 6 to zero percent. Inflation in America goes from 6 to 3 percent. Unemployment in Europe goes from zero to 6 percent. And unemployment in America goes from zero to 3 percent. For a synopsis see Table 3.17. First consider the effects on Europe. As a result, given a common mixed shock, monetary interaction produces zero inflation in Europe. However, as a side effect, it produces unemployment there. Second consider the effects on America. As a result, monetary interaction lowers inflation in America. On the other hand, it raises unemployment there. The initial loss of each central bank is zero. The common mixed shock causes a loss to the European central bank of 36 units and a loss to the American central bank of equally 36 units. Then monetary interaction reduces the loss of the European central bank from 36 to zero units. Similarly, it reduces the loss of the American central bank from 36 to 18 units. 90 Monetary Interaction between Europe and America: Case C Table 3.17 Monetary Interaction between Europe and America A Common Mixed Shock Europe America Unemployment 0 Inflation 0 Shock in A1 0 Shock in B1 6 Unemployment 0 Inflation 6 Change in Money Supply − 10 Unemployment 6 Inflation 0 Unemployment 0 Inflation 0 Shock in A2 0 Shock in B2 6 Unemployment 0 Inflation 6 Change in Money Supply − 8 Unemployment 3 Inflation 3 4) Another common mixed shock. In each of the regions, let initial unemployment be zero, and let initial inflation be zero as well. Step one refers to the common mixed shock. In terms of the model there is an increase in A1 of 6 units and an increase in A2 of equally 6 units. Step two refers to the outside lag. Unemployment in Europe goes from zero to 6 percent, as does unemployment in America. 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 money supply of 2 units and an increase in American money supply of 4 units. Step four refers to the outside lag. Unemployment in Europe stays at 6 percent. Unemployment in America goes from 6 to 3 percent. Inflation in Europe stays at zero percent. And inflation in America goes from zero to 3 percent. For an overview see Table 3.18. First consider the effects on Europe. As a result, given another common mixed shock, monetary interaction produces zero inflation in Europe. However, as a side effect, it produces unemployment there. Second consider the effects on 2. Some Numerical Examples 91 America. As a result, monetary interaction lowers unemployment in America. On the other hand, it raises inflation there. The initial loss of each central bank is zero. The common mixed shock causes a loss to the European central bank of zero units and a loss to the American central bank of 36 units. Then monetary interaction keeps the loss of the European central bank at zero units. And what is more, it reduces the loss of the American central bank from 36 to 18 units. Table 3.18 Monetary Interaction between Europe and America Another Common Mixed Shock Europe America Unemployment 0 Inflation 0 Shock in A1 6 Shock in B1 0 Unemployment 6 Inflation 0 Change in Money Supply 2 Unemployment 6 Inflation 0 Unemployment 0 Inflation 0 Shock in A2 6 Shock in B2 0 Unemployment 6 Inflation 0 Change in Money Supply 4 Unemployment 3 Inflation 3 5) Summary. Given a common demand shock, monetary interaction produces zero inflation and zero unemployment in each of the regions. Given a common supply shock, monetary interaction produces zero inflation in Europe. And what is more, monetary interaction has no effect on inflation and unemployment in America. Given a common mixed shock, monetary interaction produces zero inflation in Europe. And what is more, monetary interaction lowers inflation in America. On the other hand, it raises unemployment there. 92 Chapter 4 Monetary Cooperation between Europe and America: Case A The model of unemployment and inflation can be characterized by a system of four equations: u1 = A1 −M1 +0.5M2 (1) u2 = A2 −M2 +0.5M1 (2) π1 = B1 + M1 −0.5M2 (3) π2 = B2 + M2 −0.5M1 (4) As to policy targets there are three distinct cases. In case A the targets of monetary cooperation are zero inflation in Europe and America. In case B the targets of monetary cooperation are zero inflation and zero unemployment in each of the regions. In case C the targets of monetary cooperation are zero inflation in Europe, zero inflation in America, and zero unemployment in America. This chapter deals with case A, and the next chapters deal with cases B and C. The policy makers are the European central bank and the American central bank. The targets of monetary cooperation are zero inflation in Europe and America. The instruments of monetary cooperation are European money supply and American money supply. There are two targets and two instruments. We assume that the European central bank and the American central bank agree on a common loss function: L = π2 +π2 (5) L is the loss caused by inflation in Europe and America. We assume equal weights in the loss function. The specific target of monetary cooperation is to minimize the loss, given the inflation functions in Europe and America. Taking M. Carlberg, Monetary and Fiscal Strategies in the World Economy, 92 DOI 10.1007/978-3-642-10476-3_12, © Springer-Verlag Berlin Heidelberg 2010 ... - tailieumienphi.vn