Essays in Memory of Albert Ando
Edited by Lawrence R. Klein
8. Monetary and ﬁscal policy in a liquidity trap* Alan J. Auerbach and Maurice Obstfeld 1. INTRODUCTION Over the last several years of his life, Albert Ando devoted considerable attention to the Japanese economy. His last published work considered Japan’s economic problems during its ‘lost decade’ of the 1990s. Ando (2002a) argued that the substantial collapse in the value of household assets that occurred with the bursting of the asset price bubble was suﬃcient to explain the weakness of Japan’s aggregate demand, while at the same time suggesting that Japan’s corporations had overinvested in domestic capital. Ando (2002b) found that the Japanese national accounts understate the true size of Japan’s government sector. With weak household demand, private investment at least at a level consistent with low long-term interest rates and zero short-term interest rates, and government spending and budget deﬁcits already at high levels, Japan’s eﬀorts to stimulate its economy over the past decade have led to apparent macroeconomic policy paralysis. In earlier work (Auerbach and Obstfeld, 2004, 2005), we argued that open-market expansions of the money supply could be used eﬀectively in such an environment, as long as (1) agents in the economy already expect that the liquidity trap is not permanent; and (2) the monetary policy change is permanent and credible. The economic stimulus from such a policy would come through two channels, from a short-run increase in the inﬂation rate and a long-run reduction in the tax burden. In this chapter, we...
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