The Case for Open-Market Purchases in a Liquidity Trap
Alan Auerbach and
Center for International and Development Economics Research, Working Paper Series from Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley
Prevalent 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 Japanâ€™s recent economic experience, we use a dynamic general-equilibrium model to assess the welfare impact of open-market operations for an economy in Japanâ€™s predicament. We argue Japan can achieve a substantial welfare improvement through large open-market purchases of domestic government debt.
Keywords: liquidity trap; deflation; Japanese economy; monetary-fiscal policy mix; inflation targeting (search for similar items in EconPapers)
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Journal Article: The Case for Open-Market Purchases in a Liquidity Trap (2005)
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