DP12020 Monetary-Fiscal Interactions and the Euro Area's Malaise

Author(s): Marek Jarocinski, Bartosz Adam Mackowiak
Publication Date: May 2017
Keyword(s): fiscal theory of the price level, eurobond, Fiscal theory of the price level, self-ful lfiling expectations, zero lower bound
JEL(s): E31, E32, E63
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12020

When monetary and fiscal policy are conducted as in the euro area, output, inflation, and government bond default premia are indeterminate according to a standard general equilibrium model with sticky prices extended to include defaultable public debt. With sunspots, the model mimics the recent euro area data. We specify an alternative configuration of monetary and fiscal policy, with a non-defaultable eurobond. If this policy arrangement had been in place since the onset of the Great Recession, output could have been much higher than in the data with inflation in line with the ECB's objective.