Large Union of Two Countries

The world economy consists of two regions:the monetary union and the group of associated countriesthe rest of the world. The monetary union, in turn, consists of two countries, say Germany and France. Apart from this we shall take the same approach as before. Consider for instance a domestic credit expansion by the European Central Bank. Then what will be the impact on Germany, France, the associated countries, and the rest of the world? In answering this question we assume that the union countries are the same size and have the same behavioural functions. Figure 1 portrays the basic idea. There is perfect capital mobility across regions, subregions, and countries.