Abstract
In the following work the Levin model of monetary integration is going to be derived and then used to show that the union monetary expansion reduces income divergence between the countries in the union and that fiscal expansion in one of the countries increases income divergence. Also it is going to be shown that under the assumption of a constant total output of the two countries neither positive nor negative change in income divergence is a Paretto improvement.
The Levin model looks at the case of two countries creating a monetary union in the form of a common currency area. Let's assume that these two countries are European Union (EU) and United Kingdom (UK) and the rest of the world is just the one economy denoted W. Framework of the Levin model corresponds to the Mundell-Fleming model of an open economy with a freely floating exchange rate.
