; Discussion of Monetary and Fiscal Policy in Liquidity Trap
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Discussion of Monetary and Fiscal Policy in Liquidity Trap

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  • pg 1
									   Discussion of “Monetary and
Fiscal Policy in a Liquidity Trap”
         by Professor Auerbach

  Yasushi Iwamoto
  Hitotsubashi University
  September 3, 2004

                              1
                  Points of the AO Paper

v Open market operation (an increase in money)
  is effective even under a liquidity trap.
v Extensions of previous papers
   v OK with longer-term government debt
   v OK with banking sector (excess reserves)
   v No credibility problem
v Appraisal of Feldstain’s proposal (gradual
  increase in VAT rate)
   v Larger welfare costs
   v Credibility problem
                                                2
    Contributions of the AO paper

vThe AO paper
  vis based on a tractable, general-equilibrium
   model with a solid micro-foundation of
   sticky prices,
  vcan contain a consistent welfare analysis of
   stabilization policies,
  vsuccessfully provides a unified framework
   of evaluating policy alternatives to exit
   from a liquidity trap.

                                              3
         Existing proposals share the
                           same idea
v An increase in future M (not at a liquidity trap)
  will raise the current price level.
v Variations:
   v Persistent low interest rate; policy duration effect
   v Price-level targeting
   v Exchange rate peg
v It is difficult that the public believe that the
  central bank will increase the future M.

                                                            4
Determination mechanism of
        the initial price level




                           5
Determination mechanism of
        the initial price level




                           6
Determination mechanism of
        the initial price level




                           7
                Two views on the current
                                  status
               There is a well-established
            theory of treating a liquidity trap.



Theory is correct, but the         The BOJ works, but
BOJ does not work hard.            theory is incorrect.


                  Japan is still trapped.
                                                    8
                Which does not work?

vLimitations of the BOJ
  vDoes not adopt inflation targeting explicitly
  vDoes not commit future money growth
  vDoes not collaborate with fiscal policy
vLimitations of theory
  vBounded-rationality makes the
   computation of consistent prices difficult.
  vUncertainty has the same effect

                                                 9
        Appraisal of quantity easing
                      (section IV.D)
vWhy did it fail to ignite inflation?
vIt was not accompanied by a tax cut.
vExcess reserves absorb it.
  vMarket does not view it as permanent
  vThe public expects very high inflation at
   the exit from a liquidity trap
  vReturn of positive interest rates is distant
  vUnhealthy banking sector

                                                  10

								
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