Title Page




Monetary Finance Do Not Touch, or Handle with Care?

Prepared by Itai Agur, Damien Capelle, Giovanni Dell’Ariccia, and Damiano Sandri

Copyright Page

Copyright ©2022 International Monetary Fund

Cataloging-in-Publication Data

IMF Library

Names: Agur, Itai, author. | Capelle, Damien, author. | Dell’Ariccia, Giovanni, author. | Sandri, Damiano, author. | International Monetary Fund, publisher.

Title: Monetary finance : do not touch, or handle with care? / prepared by Itai Agur, Damien Capelle, Giovanni Dell’Ariccia, and Damiano Sandri.

Other titles: International Monetary Fund. Research Department (Series).

Description: Washington, DC : International Monetary Fund, 2022. | 2022 January. | Departmental Paper Series. | DP/2022/001 | Includes bibliographical references.

Identifiers: ISBN 9781513592541 (paper)

Subjects: LCSH: Monetary Policy. | Inflation (Finance).

Classification: LCC HG230.3 .A3 2022

The authors are indebted to Maria Soledad Martinez Peria for insightful comments and guidance throughout the research process. Chenxu Fu and Yang Liu have provided excellent research assistance.

The Departmental Paper Series presents research by IMF staff on issues of broad regional or crosscountry interest. The views expressed in this paper are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Publication orders may be placed online or through the mail:

International Monetary Fund, Publication Services

P.O. Box 92780, Washington, DC 20090, U.S.A.

T. +(1) 202.623.7430





  • Executive Summary

  • Acronyms and Abbreviations

  • 1. Introduction

  • 2. Theoretical Underpinnings of Monetary Finance

    • A. Quantitative Easing

    • B. Monetary Finance for Macroeconomic Stimulus

    • C. Monetary Finance to Prevent Self-Fulfilling Debt Crises

  • 3. Historical Evidence on the Association Between Money and Inflation

    • A. Empirical Approach

    • B. Empirical Results

  • 4. UMP Announcements and Inflation Expectations During COVID-19

  • 5. Conclusion

  • Annex 1. Monetary Finance in Historical Perspective

  • Annex 2. Transmission Channels of MF in Partial Equilibrium

  • Annex 3. Data Sources Used in Section 3

  • Annex 4. Empirical Specifications with Quadratic and Interaction Terms

  • Annex 5. Robustness of the Results on the Association Between MB and Inflation Excluding Hyperinflation Episodes

  • Annex 6. Unconventional Monetary Policies During 2020

  • Annex 7. Cross-country Regressions to Examine the Response of Inflation Expectations to UMP Announcements

  • Annex 8. Panel Regressions to Examine the Response of Inflation Expectations to UMP Announcements

  • References


  • Figure 1. Monetary Growth and Inflation

  • Figure 2. Change in Inflation after a 1 and 100 Percent Increase in the Monetary Base

  • Figure 3. Factors Influencing the Association between the Monetary Base and Inflation

  • Figure 4. UMP Programs and Direct Government Financing during COVID-19

  • Figure 5. Inflation Forecasts around UMP Announcements

  • Figure 6. UMP Announcements versus Observed Changes in the Monetary Base


  • Table 1. Conceptual Differences between Quantitative Easing and Monetary Finance


  • Box 1. The Road to Hyperinflation: Monetary Finance Under Fiscal Dominance

Executive Summary

Over the past decade and a half, the world economy has confronted two major crises—the global financial crisis (GFC) and the COVID-19 pandemic. In both, central banks responded by cutting interest rates and deploying unconventional monetary policy tools in several countries. These measures certainly helped to support economic activity and maintain financial stability. Yet various countries were pushed in a liquidity trap with interest rates close to zero while public debt rose to historic highs. Against this background, a debate ensued about whether central banks should take even more unorthodox measures, including reconsidering the well-established opposition to monetary finance (MF)—that is, the financing of the government via a permanent increase in the monetary base.

This paper reviews the theoretical arguments in favor and against MF and presents an empirical assessment of the risks that it may pose for inflation.

Those in favor of relaxing the prohibition for central banks to use MF argue that a fiscal stimulus financed with money creation would have a stronger effect on aggregate demand than a debt-financed one. This is because MF does not increase public debt and the associated expected future tax burden, coupled with the fact that a permanent increase in the monetary base should stimulate inflation and reduce real rates. Further, the academic literature has developed models wherein MF can also be used to avoid self-fulfilling runs on public debt.

Opponents of MF see it as a harbinger of fiscal dominance and a mortal risk to hard-won central bank credibility. Their key concern is that should central banks reveal some degree of tolerance for MF, fiscal authorities would push them to provide support well beyond what is appropriate for macroeconomic stabilization. Therefore, even modest MF operations could lead to a sharp increase in inflation expectations as investors and the broad public factor in the risk of fiscal dominance.

Quantifying the risks that MF may pose for inflation is an admittedly challenging issue, especially because one cannot easily identify historical episodes of MF given central banks’ reluctance to openly use this tool. With this important caveat in mind, this paper attempts to shed some light on the inflationary risks arising from MF by using two complementary empirical strategies.

First, it analyzes the association between money growth and inflation in a large panel of countries. The strength of this relation varies significantly with the initial level of inflation, central bank independence, and fiscal position. When inflation is high, central bank independence is weak, or the fiscal deficit is large— elements that point to a heightened risk of fiscal dominance—increases in the monetary base are followed by considerable price increases. Otherwise, the association between money growth and inflation tends to be modest. The analysis also detects significant non-linearities, showing that inflationary pressures increase more than proportionally with the size of the monetary expansion.

Second, the paper investigates whether announcements of unconventional monetary policy (UMP) programs during the COVID-19 pandemic triggered an increase in inflation expectations. It focuses especially on emerging market and developing economies (EMDEs) where some of these programs resembled forms of MF as they included the purchase of government bonds in primary markets and the provision of government loans—often with the explicit goal to provide fiscal support. The paper does not find evidence that these announcements led to increases in inflation expectations. However, it is important to note that these programs were modest in size and were launched in response to the exceptional shock triggered by the pandemic, likely supporting confidence that these were one-of operations.

The decades-long taboo against MF has served countries well by helping to establish central bank independence and providing a barrier against fiscal dominance. Recent theoretical analyses suggest that breaking the taboo may present some benefits for countries that confront a prolonged liquidity trap or the risk of a self-fulfilling sovereign debt crisis. Furthermore, central banks’ interventions akin to MF in EMDEs during the pandemic did not jeopardize price stability. Therefore, there seems to be merit in further examining and more openly debating about the costs and benefits associated with MF. Yet relaxing the taboo presents serious dangers to central bank independence and the credibility of monetary policy frameworks. Possible experimentation with this tool should, then, remain modest in size given the non-linearities uncovered by the analysis, be limited to countries with low inflation and sustainable fiscal positions, and be decided independently by central banks with the sole goal to enhance macroeconomic stability. History abounds with examples where MF used under fiscal dominance had devastating economic and social consequences.

Acronyms and Abbreviations


advanced economies


direct government financing


effective lower bound


emerging market


emerging market and developing economies


gross domestic product


global financial crisis


monetary base


monetary finance


quantitative easing


unconventional monetary policy

Monetary Finance: Do Not Touch, or Handle with Care?
Author: Mr. Itai Agur, Mr. Damien Capelle, Mr. Giovanni Dell'Ariccia, and Mr. Damiano Sandri