The Case for Open-Market Purchases in a Liquidity Trap
- (pp. 110-137)
AbstractPrevalent thinking about liquidity traps suggests that the perfect substitutability of money and bonds at a zero short-term nominal interest rate renders open-market operations ineffective for achieving macroeconomic stabilization goals. We show that even were this the case, there remains a powerful argument for large-scale open market operations as a fiscal policy tool. As we also demonstrate, however, this same reasoning implies that open-market operations will be beneficial for stabilization as well, even when the economy is expected to remain mired in a liquidity trap for some time. Thus, the microeconomic fiscal benefits of open-market operations in a liquidity trap go hand in hand with standard macroeconomic objectives. Motivated by Japan's recent economic experience, we use a dynamic general-equilibrium model to assess the welfare impact of open-market operations for an economy in Japan's predicament. We argue Japan can achieve a substantial welfare improvement through large open-market purchases of domestic government debt.
CitationAuerbach, Alan, J., and Maurice Obstfeld. 2005. "The Case for Open-Market Purchases in a Liquidity Trap." American Economic Review, 95 (1): 110-137. DOI: 10.1257/0002828053828473
- E43 Interest Rates: Determination, Term Structure, and Effects
- E52 Monetary Policy
- E58 Central Banks and Their Policies
- E63 Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy