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This paper studies monetary and fiscal policies in the euro area. It discusses the process of policy competition and the structure of policy cooperation. As to policy competition, the focus is on competition between the European central bank, the German government, and the French government. As to policy cooperation, the focus is on the same institutions. These are higher-dimensional issues. The policy targets are price stability and full employment. Special features of this paper are numerical simulations of policy competition and numerical solutions to policy cooperation.

The coexistence in EMU of one common monetary policy and several domestic fiscal policies raises a number of problems of both academic and political interest. First, there are reasons to assess a hypothetical need to also centralise fiscal policies in such circumstances, according to what prevails in federal states. Second, given that this hypothesis has not reached consensus in the EU, nor is it expected to do so in the near future, the issue of how to co-ordinate monetary and fiscal policies, in order to achieve the desired outcomes in both global and individual terms, arises. Third, the fact that policy spill-overs are enhanced in the EMU, the need to avoid free riding behaviour on the part of member states and the apparent non-reliance on financial markets to discipline sovereign debtors led to the option of restricting the autonomy of domestic fiscal policies by setting up constraints upon the relative levels of deficits and debts. Due to these restrictions, it is important to investigate the existence of alternative options in case of economic shocks that are specific to an economic area, or that do not equally affect all EMU members. Theory suggests that financial markets, when integrated, can provide relief by supplying the means to finance recovery. However, the lack of integration, uncovered by empirical analyses especially in peripheral EU areas, indicates that financial markets cannot be fully relied upon as mechanisms of adjustment. The current study analyses these topics of interest for monetary and fiscal policies in EMU.

AbstractWe study the effects of long‐run inflation and income taxation in an economy where households face uninsurable idiosyncratic risks. We construct a tractable competitive‐search framework that generates dispersion of prices, income and wealth. We analytically characterize the stationary equilibrium and the policy effects on individual choices. Quantitative analysis finds that monetary and fiscal policies have distinct effects on macro aggregates, such as output, savings and wealth, income and consumption inequalities. There is a hump‐shaped relationship between welfare and the respective policies. Overall, welfare is maximized by a deviation from the Friedman rule, paired with distortionary income taxation.