Monetary Policy A

An increase in European money supply lowers unemployment in Europe. On the other hand, it raises inflation there. In the numerical example, a unit increase in money supply lowers the rate of unemployment by 1 percentage point. On the other hand, it raises the rate of inflation by 1 percentage point. For instance, let initial unemployment be 2 percent, and let initial inflation be 2 percent as well. Now consider a unit increase in money supply. Then unemployment goes from 2 to 1 percent. On the other hand, inflation goes from 2 to 3 percent. The model of unemployment and inflation can be represented by a system of two equations: (1) $${\rm u} = {\rm A} - \alpha {\rm M}$$ (2) $${\rm \pi } = {\rm B} - \alpha \in {\rm M}$$ Of course this is a reduced form. Here u denotes the rate of unemployment in Europe, π is the rate of inflation in Europe, M is European money supply, α is the monetary policy multiplier with respect to unemployment, αε is the monetary policy multiplier with respect to inflation, A is some other factors bearing on the rate of unemployment in Europe, and B is some other factors bearing on the rate of inflation in Europe. The endogenous variables are the rate of unemployment and the rate of inflation in Europe.