DP4447 The Case for Open-Market Purchases in a Liquidity Trap
|Author(s):||Alan J Auerbach, Maurice Obstfeld|
|Publication Date:||June 2004|
|Keyword(s):||japan, liquidity trap, zero bound|
|JEL(s):||E43, E52, E63|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=4447|
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.