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