Uncertain Policy Regimes and Government Spending Effects

Ruoyun Mao, Wenyi Shen, Shu-Chun S. Yang

IEAS Working Paper No. 22-A004, September 2022

Money financing returns to policy debate as governments around the world adoptedmassive fiscal measures during the pandemic. Using a fully nonlinear New Keynesianmodel with endogenous policy regime switching, we show thata moderate inflation-driven switching probability to a debt-financing regime reduces money-financed spend-ing multipliers. When interacted with high government debt, money-financed spendingmultipliers fall below one, similar to the size of debt-financed spending multipliers. Thisresult holds at the zero lower bound, with long-term government debt, and under a widerange of key parameter values. Policy regime uncertainty, on the other hand, has littleeffect on debt-financed spending multipliers.