The effects of a money-financed fiscal stimulus under fiscal stress

This paper studies the local determinacy requirements and the effects of a money-financed fiscal stimulus under fiscal stress in a canonical New Keynesian model. We consider three alternative monetary policies and find that the money-financed policy adopted in Galí (2020) to keep zero-debt-increase (ZDI) leads to an unsustainable debt path, while introducing a debt growth target restores stability. A debt-targeting rule (DT) generates smaller instantaneous multipliers and larger cumulative multipliers with respect to the ZDI, whereas a mixed-targeting rule (MT) that takes both debt and inflation into consideration exaggerates the trade-off between short-run and long-run multipliers. Deficit financing decomposition shows that, relative to seigniorage, inflation and changes in the stochastic discount factor play more important roles. Moreover, welfare analysis implies that a sluggish money financing scheme causes extra welfare loss. Finally, we quantify the effects of money-financed fiscal measures in a COVID recession.