Monetary policy strategies in the world economy carlberg_5

122 Fiscal Interaction between Europe and America 2. Some Numerical Examples For easy reference, the basic model is reproduced here: u1 = A1 −G1 −0.5G2 (1) u2 = A2 −G2 −0.5G1 (2) π1 = B1 +G1 +0.5G2 (3) π2 = B2 +G2 +0.5G1 (4) s1 = G1 −T (5) s2 = G2 −T2 (6) And the Nash equilibrium can be described by two equations: 15G1 =8A1 −2A2 +6T (7) 15G2 =8A2 −2A1 +6T (8) It proves useful to study six distinct cases: - a demand shock in Europe - a supply shock in Europe - a mixed shock in Europe - another mixed shock in Europe - a common demand shock - a common supply shock. 1) A demand shock in Europe. In each of the regions, let initial unemployment be zero, let initial inflation be zero, and let the initial structural deficit be zero as well. Step one refers to a decline in the demand for European goods. In terms of the model there is an increase in A1 of 3 units and a decline in B1 of equally 3 units. Step two refers to the outside lag. Unemployment in Europe goes from zero to 3 percent. Unemployment in America stays at zero percent. Inflation in Europe goes from zero to – 3 percent. Inflation in America 2. Some Numerical Examples 123 stays at zero percent. The structural deficit in Europe stays at zero percent, as does the structural deficit in America. Step three refers to the policy response. According to the Nash equilibrium there is an increase in European government purchases of 1.6 units and a reduction in American government purchases of 0.4 units. Step four refers to the outside lag. Unemployment in Europe goes from 3 to 1.6 percent. Unemployment in America goes from zero to – 0.4 percent. Inflation in Europe goes from – 3 to – 1.6 percent. Inflation in America goes from zero to 0.4 percent. The structural deficit in Europe goes from zero to 1.6 percent. And the structural deficit in America goes from zero to – 0.4 percent. Table 5.1 presents a synopsis. Table 5.1 Fiscal Interaction between Europe and America A Demand Shock in Europe Europe America Unemployment 0 Inflation 0 Structural Deficit 0 Shock in A1 3 Shock in B1 − 3 Unemployment 3 Inflation − 3 Change in Govt Purchases 1.6 Unemployment 1.6 Inflation − 1.6 Structural Deficit 1.6 Unemployment 0 Inflation 0 Structural Deficit 0 Unemployment 0 Inflation 0 Change in Govt Purchases − 0.4 Unemployment − 0.4 Inflation 0.4 Structural Deficit − 0.4 124 Fiscal Interaction between Europe and America First consider the effects on Europe. As a result, given a demand shock in Europe, fiscal interaction lowers unemployment and deflation in Europe. On the other hand, it raises the structural deficit there. Second consider the effects on America. As a result, fiscal interaction produces overemployment and inflation in America. And what is more, it produces a structural surplus there. The loss functions of the European government and the American government are respectively: L1 = u1 +s1 (9) L2 = u2 +s2 (10) The initial loss of the European government is zero, as is the initial loss of the American government. The demand shock in Europe causes a loss to the European government of 9 units and a loss to the American government of zero units. Then fiscal interaction reduces the loss of the European government from 9 to 5.12 units. On the other hand, fiscal interaction increases the loss of the American government from zero to 0.32 units. 2) A supply shock in Europe. In each of the regions let initial unemployment be zero, let initial inflation be zero, and let the initial structural deficit be zero as well. Step one refers to the supply shock in Europe. In terms of the model there is an increase in B1 of 3 units and an increase in A1 of equally 3 units. Step two refers to the outside lag. Inflation in Europe goes from zero to 3 percent. Inflation in America stays at zero percent. Unemployment in Europe goes from zero to 3 percent. And unemployment in America stays at zero percent. Step three refers to the policy response. According to the Nash equilibrium there is an increase in European government purchases of 1.6 units and a reduction in American government purchases of 0.4 units. Step four refers to the outside lag. Unemployment in Europe goes from 3 to 1.6 percent. Unemployment in America goes from zero to – 0.4 percent. Inflation in Europe goes from 3 to 4.4 percent. Inflation in America goes from zero to 0.4 percent. The structural deficit in Europe goes from zero to 1.6 percent. And the structural deficit in America goes from zero to – 0.4 percent. Table 5.2 gives an overview. 2. Some Numerical Examples 125 Table 5.2 Fiscal Interaction between Europe and America A Supply Shock in Europe Europe America Unemployment 0 Inflation 0 Structural Deficit 0 Shock in A1 3 Shock in B1 3 Unemployment 3 Inflation 3 Change in Govt Purchases 1.6 Unemployment 1.6 Inflation 4.4 Structural Deficit 1.6 Unemployment 0 Inflation 0 Structural Deficit 0 Unemployment 0 Inflation 0 Change in Govt Purchases − 0.4 Unemployment − 0.4 Inflation 0.4 Structural Deficit − 0.4 First consider the effects on Europe. As a result, given a supply shock in Europe, fiscal interaction lowers unemployment in Europe. On the other hand, it raises the structural deficit there. And what is more, as a side effect, it raises inflation. Second consider the effects on America. As a result, fiscal interaction produces overemployment and inflation in America. And what is more, it produces a structural surplus there. The initial loss of each government is zero. The supply shock in Europe causes a loss to the European government of 9 units and a loss to the American government of zero units. Then fiscal interaction reduces the loss of the European government from 9 to 5.12 units. On the other hand, it increases the loss of the American government from zero to 0.32 units. 3) A mixed shock in Europe. In each of the regions, let initial unemployment be zero, let initial inflation be zero, and let the initial structural deficit be zero as well. Step one refers to the mixed shock in Europe. In terms of the model there is 126 Fiscal Interaction between Europe and America an increase in A1 of 6 units. Step two refers to the outside lag. Unemployment in Europe goes from zero to 6 percent. Unemployment in America stays at zero percent. 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 government purchases of 3.2 units and a reduction in American government purchases of 0.8 units. Step four refers to the outside lag. Unemployment in Europe goes from 6 to 3.2 percent. Unemployment in America goes from zero to – 0.8 percent. Inflation in Europe goes from zero to 2.8 percent. Inflation in America goes from zero to 0.8 percent. The structural deficit in Europe goes from zero to 3.2 percent. And the structural deficit in America goes from zero to – 0.8 percent. For a synopsis see Table 5.3. Table 5.3 Fiscal Interaction between Europe and America A Mixed Shock in Europe Europe America Unemployment 0 Inflation 0 Structural Deficit 0 Shock in A1 6 Shock in B1 0 Unemployment 6 Inflation 0 Change in Govt Purchases 3.2 Unemployment 3.2 Inflation 2.8 Structural Deficit 3.2 Unemployment 0 Inflation 0 Structural Deficit 0 Unemployment 0 Inflation 0 Change in Govt Purchases − 0.8 Unemployment − 0.8 Inflation 0.8 Structural Deficit − 0.8 ... - tailieumienphi.vn