Working Paper: NBER ID: w10290
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. In an earlier paper, we showed that this reasoning does not hold, that open-market operations can provide substantial macroeconomic benefits and facilitate the use of powerful fiscal policy tools even in a liquidity trap. In this paper, we consider an alternative approach that has been suggested for use in a liquidity trap, a scheduled increase in consumption tax rates. We find that such a policy could, indeed, increase short-run consumption, but would be less effective at increasing welfare or accelerating a country's exit from a liquidity trap. Though a variant of this tax policy might induce exit from a liquidity trap, the impact of welfare is negative in this case as well. We also argue that this alternative tax-rate-based approach is subject to more severe credibility problems than the monetary policy approach explored in our original paper.
Keywords: liquidity trap; open-market operations; consumption tax; economic welfare
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) | macroeconomic stabilization (E63) |
| increase in consumption tax rates (H29) | short-term increase in consumption (E21) |
| increase in consumption tax rates (H29) | long-term economic welfare (D69) |
| credibility issues surrounding tax policy (H26) | effectiveness of tax-based approaches to economic stimulation (H29) |
| commitment to raise tax rates over time (H26) | sustaining an increase in the money supply (E51) |