Monetary financing with interest-bearing money
Published in Bank of England Staff Working Papers, 2019
(with Ryland Thomas)
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.