The Case for Open-Market Purchases in a Liquidity Trap

Alan Auerbach and Maurice Obstfeld

No 4447, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: 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 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 that Japan can achieve a substantial welfare improvement through large open-market purchases of domestic government debt.

Keywords: japan; liquidity trap; zero bound (search for similar items in EconPapers)
JEL-codes: E43 E52 E63 (search for similar items in EconPapers)
Date: Written
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Related works:
Working Paper: The Case for Open-Market Purchases in a Liquidity Trap (2004)
Working Paper: The Case for Open-Market Purchases in a Liquidity Trap (2004)
Working Paper: The Case for Open-Market Purchases in a Liquidity Trap (2003)
Journal Article: The case for open-market purchases in a liquidity trap (2003)
Journal Article: The Case for Open-Market Purchases in a Liquidity Trap (2005)
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