Money-Financed Fiscal Programs: A Cautionary Tale

48 Pages Posted: 5 Jun 2017

See all articles by William B. English

William B. English

Government of the United States of America - Division of Monetary Affairs

Christopher J. Erceg

Board of Governors of the Federal Reserve System

David Lopez-Salido

Board of Governors of the Federal Reserve System

Date Written: 2017-06

Abstract

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

English, William B. and Erceg, Christopher J. and Lopez-Salido, David, Money-Financed Fiscal Programs: A Cautionary Tale (2017-06). FEDS Working Paper No. 2017-060. Available at SSRN: https://ssrn.com/abstract=2979976 or http://dx.doi.org/10.17016/FEDS.2017.060

William B. English (Contact Author)

Government of the United States of America - Division of Monetary Affairs ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-736-5645 (Phone)
202-452-3819 (Fax)

Christopher J. Erceg

Board of Governors of the Federal Reserve System ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2575 (Phone)
202-736-5638 (Fax)

David Lopez-Salido

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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