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The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap
Lars E. O. Svensson Sveriges Riksbank; Stockholm University - Institute for International Economic Studies (IIES); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR) October 2000 NBER Working Paper No. W7957 Abstract: The paper examines the transmission mechanism of monetary policy in an open economy with and without a binding zero bound on nominal interest rates. In particular, a foolproof way of escaping from a liquidity trap is presented, consisting of a price-level target path, a devaluation of the currency and a temporary exchange rate peg, which is later abandoned in favor of price-level or inflation targeting when the price-level target has been reached. This will jump-start the economy and escape deflation by a real depreciation of the domestic currency, a lower long real interest rate, and increased inflation expectations. The abandonment of the exchange-rate peg and the shift to price-level or inflation targeting will avoid the risk of overheating. Some conclusions for Japan are included.
JEL Classifications: E52, F31, F33, F41 Working Paper SeriesDate posted: October 12, 2000 ; Last revised: June 25, 2001Suggested CitationContact Information
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