where the superscript N refers to the national case with full policy autonomy. Given this
reaction function and the expectations of the private sector, the government decides about
its reform efforts by taking the respective budget constraint (2) into account. The rate of
inflation (6) is plugged into the budget constraint and solved for xi which yields
θB(Fi
xi = i
- ɑj-d (y** - yj
νι
(7)
The parameters used throughout are defined in table 1.
Table 1: Definitions
|
ν1 = bθ B + d |
ω1 =(θB )2 + Θg |
|
ν2 = bθB + d/ n |
ω2 = (θB )2 + θG / n |
Taking this constraint into account and optimizing the government's objective
function with respect to si yields
SN = cω^L±b(y*Ξyi)l
ι λν12 + c 2ω1
(8)
which can then again be used in the budget constraint to yield fiscal policy as
x1N
FιλθBνι - (y* - yι ∖⅛ivl + cω )
λν12 + c2ω1
(9)
Not surprisingly, given the budget constraint of the government, the higher the
exogenous fiscal requirements, the higher structural reforms will be. They will also increase