Money-Financed Fiscal Programs: A Cautionary Tale
48 Pages Posted: 5 Jun 2017
Date Written: 2017-06
A number of prominent economists and policymakers have argued that money-ﬁnanced ﬁscal programs (helicopter drops) could be eﬃcacious in boosting output and inﬂation in economies facing persistent economic weakness, very low inﬂation, and signiﬁcant ﬁscal strains. We employ a fairly conventional macroeconomic model to explore the possible eﬀects of such policies. While we do ﬁnd that money-ﬁnanced ﬁscal programs, if communicated successfully and seen as credible by the public, could provide signiﬁcant stimulus, we underscore the risks that would be associated with such a program. These risks include persistently high inﬂation if the central bank fully adhered to the program; or alternatively, that such a program would be ineﬀective in providing stimulus if the public doubted the central bank’s commitment to such an extreme strategy. We also highlight how more limited forms of monetary and ﬁscal cooperation – such as a promise by the central bank to be more accommodative than usual in response to ﬁscal stimulus – may be more credible and easier to communicate, and ultimately more eﬀective in providing economic stimulus.
Keywords: DSGE Model, Fiscal policy, Liquidity Trap, Monetary policy, Currency union
JEL Classification: E52, E58
Suggested Citation: Suggested Citation