3.2. Government Utility
Having established how the optimal policies change through the introduction of
monetary union obviously raises the question of how the governments’ utilities change.
This is mainly a function of the output effects that changes in fiscal policy have and the
aversion of governments to structural reform.
Losses under national monetary policy are given as
LGi(N)=[-(y*
yi
-xN]2 +θG
+ λsN
(15)
where N refers to the case of national autonomy and xN and sN are the values expressed in
(8) and (9) respectively. The loss under monetary union (M) follows from (13) and (14) as
LGi (M)= [-(
yi
+θG
xM
yi
θB
+λsM
(16)
Comparing the losses under the two regimes, government i will decide to enter the
(symmetric) monetary union if LGi (N)> LGi (M). This is equivalent to
sM2]
θG +θB2
θB2
(17)
A high aversion to structural reforms (measured as λ) makes the monetary union
attractive because these fall under monetary union. Therefore, they enter on the left hand
side. The RHS of the inequality measures the negative effects of a higher distortionary
taxation. Since xM > xN there will be an output loss associated with the entry into monetary
union. Whether government i gains or loses from entering the monetary union is thus
13
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