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A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Eggertsson, Gauti B. Article Macroeconomic policy in a liquidity trap NBER Reporter Provided in Cooperation with: National Bureau of Economic Research (NBER), Cambridge, Mass. Suggested Citation: Eggertsson, Gauti B. (2017) : Macroeconomic policy in a liquidity trap, NBER Reporter, National Bureau of Economic Research (NBER), Cambridge, MA, Iss. 1, pp. 25-29 This Version is available at: http://hdl.handle.net/10419/178745 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. 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Eggertsson The main focus of my research for a bit of attention over the years, perhaps nearly two decades has been macroeco- due to the fact that during the Great nomic policy during periods when the Recession the Federal Reserve used the central bank has cut the short-term nom- analysis, and closely related work by inal interest rate to zero, periods that are other authors, as part of the rationale for often referred to as exhibiting a liquidity its “forward guidance” policy once the trap. In this summary, I describe my key ZLB became a concern.2 Several other Gauti B. Eggertsson is a mac- conclusions. central banks — including the Bank of roeconomist and a professor of The work can be divided quite neatly Canada, the European Central Bank, economics at Brown University. into four parts, roughly following the the Bank of Japan, and the Bank of He received his Ph.D. in econom- time line in which it was written. I high- England — utilized this research for sim- ics from Princeton University in light each phase of my research agenda ilar policy purposes. 2004, after having completed his and three generations of models which Another important result was an B.S. in economics at the University evolved along the way. While I focus “irrelevance” proposition, the idea that of Iceland. primarily on my own research, I must increasing the money supply at a zero He has worked at research acknowledge at the outset that many interest rate has no effect on output or departments of the International others have contributed to this research prices if it does not change expectations Monetary Fund and the Federal agenda. about future interest rates. Woodford Reserve Bank of New York. He has and I further showed that it was irrel- also been a visiting faculty mem- First-Generation Models evant how this was done, that is, which ber at Princeton, Yale University, assets the central bank bought in order and Columbia University, where My interest in the liquidity trap was to increase the money supply. This was he taught international finance triggered by events in Japan in the late a quite controversial proposition when and macroeconomics at graduate 1990s. At that time, Japan suffered from reported, but one that has stood the test and undergraduate levels. subpar growth and deflation, and the of time, with several central banks more Eggertsson has published in short-term interest rate had collapsed to than doubling the monetary base during a variety of professional journals, zero. If it could happen in Japan, it could the most recent crisis, using various pur- including the American Economic happen here as well, and it seemed to me chasing schemes, with little or no appar- Review and the Q uarterly Journal a first-order priority for those concerned ent effect on prices.3 This was consistent of Economics. The main focus of his with macroeconomic policy to under- with the empirical prediction of that work is the analysis of monetary stand those events. paper. It was a direct violation, however, and fiscal policy over the business My first published work on this topic of the quantity theory of money, which cycle, both from a modern and a was written with my adviser, Michael was a reigning paradigm in the ’90s. historical perspective. Woodford.1 Central to it was the idea A second major theme of my that once a central bank is constrained by early work was how policies aimed at the zero lower bound (ZLB), it can still manipulating expectations, such as for- on Paul Krugman’s proposal that have an impact on the economy by giving ward guidance, could be made credi- the Bank of Japan needed to “com- markets guidance about the evolution ble. Specifically, I wanted to know what mit to being irresponsible.”4 It was a of future interest rates, rates that would could be done by the government to back theme I would return to repeatedly prevail once the ZLB is no longer bind- up an announcement of future inter- in work on the Great Depression in ing. For example, it could set explicit vention by the appropriate use of fis- order to interpret various govern- thresholds, saying that the interest rate cal policy, exchange rate policy, or vari- ment policy actions in the 1930s, will stay at zero until the price level or ous forms of quantitative easing. This an agenda I took up after leaving unemployment rate reaches a particu- was the main focus of the paper, “The graduate school at the urging of one lar level, an idea we formalized in the Deflation Bias and Committing to Being of my advisers, Ben Bernanke, and paper. These results have received quite Irresponsible,” the title of which played many others. NBER Reporter • No. 1, March 2017 25 The Great Depression was invited to give the paper as a part of linked to my earlier theoretical dissertation and the Liquidity Trap the Bank of Japan’s Annual Conference work, while the second aimed at building a in 2006. This meeting was attended by a second generation of New Keynesian mod- My work on the Great Depression large part of the governing board at the els to understand what happened, going yielded three major conclusions. First, bank, and in a youthful fit of over-con- deeper into the origin of the 2008 crisis it gave a somewhat novel interpreta- fidence, I felt that perhaps warning that and the Great Depression. tion of the U.S. recovery that started in they were about to repeat the mistake of Within the first line, I examined how 1933, when Franklin Delano Roosevelt 1937 would make a difference. The talk, of fiscal policy tools could be used instead took office. It heavily emphasized the role course, had no apparent effect at the time. of, or in addition to, monetary policy in of expectations about future policy and The bank raised the short-term nominal responding to the crisis. Perhaps the most the price level, something that was largely rate a few weeks later — precisely what important result was that the “multiplier missing from the existing literature, which I warned could lead to a recession. The of government spending” — the increase focused more on static movements in the phrase “The Mistake of 1937” caught on, in output as a consequence of an increase money supply or government spending as and is used routinely by policy makers and in government spending — was theoreti- explanatory variables.5 One of the main pundits talking about this period. This was cally much greater at the ZLB than under goals of my work on the regime change in probably driven by the fact that Krugman normal circumstances.8 I proved that it 1933 was to model it in the context of an devoted a New York Times column to the had to be above unity in a standard New infinitely repeated game; then, one could paper and used the title for his column Keynesian model. This implied that exist- interpret many of the actions of the gov- when warning the Fed about raising rates ing empirical estimates of government ernment as having directly affected expec- prematurely. spending multipliers were not useful. tations, something I spent considerable Those estimations depended upon data time arguing did indeed happen. A sec- The 2008 Crisis: Second- generated under regular circumstances ond and somewhat more provocative con- Generation ZLB Models when the short-term nominal interest rate clusion was that some of the most con- was positive. This had strong policy impli- troversial elements of the New Deal, such The work described above was done cations, as the Obama administration was as the National Industrial Recovery Act, prior to the economic crisis of 2008, which designing the largest fiscal stimulus pro- were expansionary, rather than contrac- led me to abandon further work on eco- gram seen since the end of World War II. tionary, as the conventional wisdom held nomic history. The 2008 crisis looked a While this result was anticipated in some at the time, but the act included tem- lot like the type of economic crises that of my earlier work, I now showed it explic- porary but highly controversial policies I already had analyzed in previous work itly with a series of analytical propositions.

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