Monetary financing produces neither high inflation nor miraculous fiscal multipliers

Thu, 01 Jan 2026 00:00:00 +0000

When central banks pay interest on reserves — as the Federal Reserve has done since October 2008 and as is standard operating procedure today — does financing fiscal stimulus by permanently expanding the central bank’s balance sheet produce higher output than debt-financed stimulus? Van der Kwaak (2024) argues the answer is no in most model configurations, and only modestly yes in a specific extension.

The motivation is practical: with government debt at high levels in many advanced economies, the private sector may be unable or unwilling to absorb additional bonds needed to fund fiscal stimuli. One alternative is monetary financing — the central bank permanently purchases the extra bonds issued to fund the stimulus (as proposed by Gali 2020b for COVID-era policy). A prior key paper (Gali 2020a) found money-financed stimuli to be substantially more effective than debt-financed ones, but that result was derived in a model where the central bank does not pay interest on reserves, so the policy rate becomes endogenous under money financing. Van der Kwaak shows this assumption is at odds with how modern central banks operate: post-GFC balance sheet expansions by the Federal Reserve and ECB have been financed almost entirely by interest-bearing reserves, with non-interest-paying currency showing no meaningful deviation from trend.

Financial Fragility and the Fiscal Multiplier

Wed, 01 Jan 2025 00:00:00 +0000

Research question and motivation: Does fiscal stimulus still work when it is financed through a banking system that is undercapitalized and holds large quantities of risky domestic government bonds? This was a first-order policy question in Southern Europe (Spain, Italy, Portugal — “SIP”) during the 2011–2013 European sovereign debt crisis, and the authors argue it is relevant again as central banks raise rates after the Zero Lower Bound. Motivating stylized facts: Spanish banks held domestic sovereign debt equal to more than 150% of Tier-1 capital (Italian banks ~200%, Greek banks ~250% at end-2011); CDS spreads on Italian and Spanish sovereign debt rose from ~100 bps in January 2010 to above 400 bps in 2012–2013 (Portugal exceeded 1000 bps at end-2011); VAR evidence shows sovereign-spread pass-through to corporate lending rates is nearly complete within six months. Gennaioli et al. (2018) document that 12.7% of emerging-market commercial bank assets are (mostly domestic) government bonds, extending relevance beyond Europe.

Christiaan Van Der Kwaak | Macro Paper Warehouse

Monetary financing produces neither high inflation nor miraculous fiscal multipliers

Financial Fragility and the Fiscal Multiplier