Uncertain policy regimes and government spending effects

Money financing returns to policy debate as governments around the world adopted massive fiscal measures during the pandemic. Using a fully nonlinear New Keynesian model with endogenous policy regime switching, we show that a moderate inflation-driven switching probability to a debt-financing regime reduces money-financed spending multipliers. When interacted with high government debt, money-financed spending multipliers fall below one, similar to the size of debt-financed spending multipliers. This result holds at the zero lower bound, with long-term government debt, and under a wide range of key parameter values. Policy regime uncertainty, on the other hand, has little effect on debt-financed spending multipliers.