which, with rational expectations, becomes
n*
⅛ ∑i=ι (yi
Yi )+n∙ ∑i
i=1
xi
θB
(12)
Given this changed central bank reaction function the government's budget constraint
is changed as well. Using this altered budget constraint in the objective function yields
structural reform efforts of
sM = cω2 [Fi + b(У* - ʃɔ]
i λν1ν2 + c2ω2
(13)
(14)
and leads to a fiscal policy of
χM = FiλθBν2 - (У* - yι ^fλdlν2 + cω )
i λν1ν2 + c2ω2
A comparison of the results in (9) and (14) leads to
Result 1:
A monetary union among symmetric countries will lead to a more distortive fiscal policy in
all countries iff bθG> dθB. In this case, structural reform efforts will fall in the member
countries. The union wide rate of inflation will be higher than the rate of inflation before
unification while the output level falls.
Proof: See the Appendix.
Whether xiM > xiN and all further results depend upon whether bθG> dθB holds.
Unless the central bank's aversion against inflation is considerably larger than that of the
government, this inequality will be fulfilled. Since b is the contribution of tax policy to the
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