The Case for Open-Market Purchases in a Liquidity Trap

50 Pages Posted: 5 Jul 2003 Last revised: 11 Apr 2010

See all articles by Alan J. Auerbach

Alan J. Auerbach

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Maurice Obstfeld

University of California, Berkeley; Peterson Institute for International Economics; National Bureau of Economic Research; Centre for Economic Policy Research

Multiple version iconThere are 2 versions of this paper

Date Written: July 2003

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

Suggested Citation

Auerbach, Alan Jeffrey and Obstfeld, Maurice, The Case for Open-Market Purchases in a Liquidity Trap (July 2003). NBER Working Paper No. w9814. Available at SSRN: https://ssrn.com/abstract=421775

Alan Jeffrey Auerbach (Contact Author)

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Maurice Obstfeld

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Centre for Economic Policy Research ( email )

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