as the difference between actual and desired output increases. The higher this gap is, the
more incentive the government has not to increase it further by pushing fiscal deficits
higher. Hence, xi will be lowered which, ceteris paribus, will require that si increases (given
the budget constraint). There is hence a positive relation between structural reforms and the
output distortions in economy i (equation 8). However, fiscal revenue increases if there is a
large financial need and therefore (9) is increasing in Fi but falling in (y* - yi ).
3. Monetary Union Among Symmetric Countries
3.1. Government Policy
Having derived the national case, I now turn to monetary union and begin with the case of
symmetric countries, which is thought of as capturing a monetary union among similar
countries. This can be thought to reflect a group of countries such as the present WAEMU
members which are relatively similar in comparison to the differences that are displayed by
the larger group of ECOWAS members (Debrun et al. 2002).
While the governments’ objective functions do not change, the utility function of the
central bank becomes
LCCB = 1
2
θCCB ∏2 +1 ∑n=t(y,- y* )2
n i=1
(10)
where n is the number of participants to the monetary union. As argued above, it is
henceforth assumed that θB = θCCB .
Given these preferences, the ECB's reaction function is
∏ + ɪ ∑n=1[(y*
(11)
1 +θB
10