Monetary Financing with Interest-Bearing Money

Recent results suggesting that monetary financing is more expansionary than bond financing in standard New Keynesian models rely on a duality between policy rules for the rate of money growth and the short-term bond rate, rather than a special role for money. We incorporate two features into a simple sticky-price model to generalize these results. First, that money may earn a strictly positive rate of return, motivated by recent debates on the introduction of central bank digital currencies and the introduction of interest-bearing reserves. This allows money-financed transfers to be used as a policy instrument at the effective lower bound, without giving up the ability to use the short-term bond rate to stabilize the economy in normal times. Second, a simple financial friction generates a wealth effect on household spending from government liabilities. Though temporary money-financed transfers to households can stimulate spending and inflation when the short-term bond rate is constrained by a lower bound, similar effects could be achieved by bond-financed tax cuts. So our results do not provide compelling reasons to choose monetary financing rather than bond financing.