Small Union as a Whole

In this part, the associated countries are introduced into the model. Strictly speaking, we consider a regional economy that is made up of two subregions, the monetary union and the group of associated countries. The exchange rate between the union and the associated countries is fixed. The exchange rate between the union and the rest of the world is flexible. The same holds for the exchange rate between the associated countries and the rest of the world. Index 1 denotes the monetary union, 2 is the group of associated countries, and 3 is the rest of the world. Figure 1 visualizes the basic idea.