The Interaction of Fiscal and Monetary Policy in the Euro Area. The Participation of Financial Intermediaries.

<p>It is a generally accepted fact that there are two core pillars for formation a competent and sustained macroeconomic policy: government authority and central bank. This paper sheds light on the significance of the third agent namely commercial banks.</p><p>Present participation is considered in the context of growing sovereign default probability in several European countries, participants of European Monetary Union. There are some problems which are actual for us. First of all, we analyze the dynamics of public debt and its dependence on the banking system in the various countries of the Eurozone in response to regulatory actions of the European Central Bank (ECB) and the fiscal authorities in the countries. Secondly, how does government default possibility alter the ways of interaction between fiscal and monetary policies? Thirdly, this research adds commercial banks in the customary model of the double-sided interaction.</p><p>As a result of this work, we obtain a model in terms of fiscal stress, which will be relevant for the euro area . ECB policy will not only affect the equilibrium level of inflation, but also on the probability of default on government debt. This issue has already been discussed earlier in the Uribe&rsquo;s work (2006). We also consider the risk management policy interest rate, as Uribe - however, in our model, the ECB minimizes the probability of default of the government in order to avoid defaulting commercial banks and , as a consequence, serious adverse shocks in the financial system and in equilibrium output .</p>