NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Monetary and Fiscal Remedies for Deflation

Alan Auerbach, Maurice Obstfeld

NBER Working Paper No. 10290
Issued in February 2004
NBER Program(s):   EFG   IFM   ME   PE

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. In an earlier paper, we showed that this reasoning does not hold, that open-market operations can provide substantial macroeconomic benefits and facilitate the use of powerful fiscal policy tools even in a liquidity trap. In this paper, we consider an alternative approach that has been suggested for use in a liquidity trap, a scheduled increase in consumption tax rates. We find that such a policy could, indeed, increase short-run consumption, but would be less effective at increasing welfare or accelerating a country's exit from a liquidity trap. Though a variant of this tax policy might induce exit from a liquidity trap, the impact of welfare is negative in this case as well. We also argue that this alternative tax-rate-based approach is subject to more severe credibility problems than the monetary policy approach explored in our original paper.

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Document Object Identifier (DOI): 10.3386/w10290

Published: Auerbach, Alan J. and Maurice Obstfeld. "Monetary And Fiscal Remedies For Deflation," American Economic Review, 2004, v94(2,May), 71-75. citation courtesy of

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