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Cambridge Journal of Economics Advance Access originally published online on June 12, 2006
Cambridge Journal of Economics 2007 31(1):1-23; doi:10.1093/cje/bel010
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Right arrow E52 - Monetary Policy (Targets, Instruments, and Effects)
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© The Author 2006. Published by Oxford University Press on behalf of the Cambridge Political Economy Society. All rights reserved.

A simple model of three economies with two currencies: the eurozone and the USA

Wynne Godley and Marc Lavoie*

* CERF—University of Cambridge, and Department of Economics at the University of Ottawa, respectively

Address for correspondence: Marc Lavoie, Department of Economics, University of Ottawa, Ottawa, Ontario, Canada, K1N 6N5; email: marc.lavoie{at}uottawa.ca

This paper presents a Keynesian model which describes three countries trading merchandise and financial assets with one another. It is initially assumed that all three countries have independent fiscal policies but that two of the countries share a currency, hence the model can be used to make a preliminary analysis of the conduct of economic policy in ‘the eurozone’ vis-à-vis the rest of the world—‘the USA’. The main conclusion will be that, if all three countries do indeed operate independent fiscal policies, the system will work under a floating currency regime, but only so long as the European central bank is prepared to modify the structure of its assets by accumulating an ever rising proportion of bills issued by any ‘weak’ euro country.

Key Words: Three-country models • Eurozone fiscal policy • ECB monetary policy

JEL classifications: F41, F42, F47

Manuscript received March 7, 2005; final version received February 7, 2006.


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