Working Paper: CEPR ID: DP4447
Authors: Alan J. Auerbach; Maurice Obstfeld
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
JEL Codes: E43; E52; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| open market operations (E52) | improved welfare outcomes (I38) |
| open market operations (E52) | macroeconomic stabilization goals (E63) |
| open market operations (E52) | microeconomic fiscal benefits (H39) |
| large-scale open market purchases of domestic government debt (H63) | substantial welfare improvements (I38) |