Discussion of Monetary and Fiscal Policy in Liquidity Trap by liaoqinmei


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

  Yasushi Iwamoto
  Hitotsubashi University
  September 3, 2004

                  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
    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.

         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.

Determination mechanism of
        the initial price level

Determination mechanism of
        the initial price level

Determination mechanism of
        the initial price level

                Two views on the current
               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.
                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

        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


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