Monetary Policy in Europe A

For ease of exposition we assume that 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 European money supply lowers unemployment in Germany and France. On the other hand, it raises producer inflation there. Here producer inflation in Germany refers to the price of German goods. Similarly, producer inflation in France refers to the price of French goods. The model of unemployment and inflation can be represented by a system of four equations: (1) $${\rm u}_1 = {\rm A}_1 - {\rm M}$$ (2) $${\rm u}_2 = {\rm A}_2 - {\rm M}$$ (3) $${\rm \pi }_1 = {\rm B}_1 + {\rm M}$$ (4) $${\rm \pi }_2 = {\rm B}_2 + {\rm M}$$ Of course this is a reduced form. Here u1 denotes the rate of unemployment in Germany, u2 is the rate of unemployment in France, π1 is the rate of inflation in Germany, π2 is the rate of inflation in France, M is European money supply, A1 is some other factors bearing on the rate of unemployment in Germany, A2 is some other factors bearing on the rate of unemployment in France, B1 is some other factors bearing on the rate of inflation in Germany, and B2 is some other factors bearing on the rate of inflation in France. The endogenous variables are the rate of unemployment in Germany, the rate of unemployment in France, the rate of inflation in Germany, and the rate of inflation in France.