Fiscal Stimuli: Monetary Versus Fiscal Financing

Abstract

In this paper, we investigate the use of money supply issued by the central bank to support expansionary fiscal interventions. We develop and estimate a New Keynesian model using US data for the sample 1960Q1 - 2019Q4. We conduct a quantitative counterfactual analysis to assess the effects of a fiscal stimulus that does not result in an increase in public debt, as it is financed by money supply. Our impulse response analysis indicates that both increases in government spending and transfers that are monetary financed have positive effects on private consumption, investment and output. However, the expansionary impact of monetary-financed fiscal shocks comes at a cost: an increase in inflation. Our sub-sample analysis indicates that monetary-financed fiscal stimuli would have had a greater positive impact on the economy during the Great Moderation. Lastly, we find that as the debt burden increases, the positive effects of a monetary-financed fiscal stimulus diminish.

Keywords: Fiscal Policy, Monetary Policy, Bayesian Estimation.