changes in a monetary union arise from preference aggregation. Here, structural policy
changes are important and therefore only structural differences across economies are
allowed. This, of course, abstracts from many effects that have been discussed in the
literature, focusing on differences in preferences in the creation of fixed exchange rates and
monetary unions (see e.g. Berger et al. 2001).
2.2. The Situation before Monetary Union
As a benchmark, I begin with the situation before monetary union where countries have
monetary autonomy. Assuming that exchange rates follow purchasing power parity ensures
that exchange rate movements have no influence on output, and that the rate of inflation is
determined by domestic monetary policy only.
The game structure used is Stackelberg where the fiscal authority is the Stackelberg
leader; the solution concept is subgame-perfect equilibrium. The time structure is as
follows: (i) the government decides about the structural reform package si implying a
certain fiscal policy package xi , (ii) having observed this, the private sector forms
expectations about the rate of inflation πie, (iii) the central bank sets the rate of inflation πi ,
and (iv) output is determined. The model is solved by backward induction.
Since the government is Stackelberg leader it takes the reaction of the central bank
into account when making its policy choices. The central bank's best response is
N
πi
πe + (y* - Yi )+ xi
1 + θB
(5)
which, with rational expectations, becomes

(6)
More intriguing information
1. The economic value of food labels: A lab experiment on safer infant milk formula2. The name is absent
3. Types of Tax Concessions for Promoting Investment in Free Economic and Trade Areas
4. The name is absent
5. Cryothermal Energy Ablation Of Cardiac Arrhythmias 2005: State Of The Art
6. The name is absent
7. Neural Network Modelling of Constrained Spatial Interaction Flows
8. The name is absent
9. The name is absent
10. An institutional analysis of sasi laut in Maluku, Indonesia