By Jordi Galí
I analyze the effects of an increase in government purchases financed entirely through seignorage, in both a classical and a New Keynesian framework, and compare them with those resulting from a more conventional debt-financed stimulus. My findings point to the importance of nominal rigidities in shaping those effects. Under a realistic calibration of such rigidities, a money-financed fiscal stimulus is shown to have very strong effects on economic activity, with relatively mild inflationary consequences. If the steady state is sufficiently inefficient, an increase in government purchases may increase welfare even if such spending is wasteful.
On a regular basis, I get emails enquiring how to publish on RePEc some new system that will solve all of the world’s economic problems. Usually, this involves distributing money. This paper is also about distributing money to solve economic problems, but there are two major differences: Jordi Galí is no lunatic, and he only seeks to deal with temporary economic problems as they arise during a business cycle. The key here that nominal rigidities in prices and wages can do their magic and increase aggregate demand. Of course, prices eventually rise and the stimulus dissipates, but the temporary boosts is valuable when it matters most, given a level of rigidity that is plausible. The good old unemployment-inflation trade-off, only with a lag. I wonder though what will happen to the ridigity of prices and wages in a world where money policy becomes active in such ways. Wouldn’t they become more flexible in anticipation of more frequent money stimuli?