Money-Financed Fiscal Stimulus: The Effects of Implementation Lag

Previous studies argue that, based on the New Keynesian framework, a fiscal stimulus
financed by money creation has a strong positive effect on output under a reasonable
degree of nominal price rigidities. This paper investigates the effects of an
implementation lag in a money-financed fiscal stimulus on output. We show that if a
money-financed government purchase has a time lag between the decision and the
implementation: (1) it may cause a recession rather than a boom when the economy is in
normal times; (2) it may deepen a recession when the economy is in a liquidity trap; (3)
the longer the implementation lag, the deeper the recession; and (4) the depth of the
recession depends on the interest semi-elasticity of money demand. Our results imply
that, if money demand is unstable, the money-financed fiscal stimulus with an
implementation lag may have unstable effects on output, in contrast to the debt-financed
fiscal stimulus.