Credible Commitment to Optimal Escape from a Liquidity Trap: The Role of the Balance Sheet of an Independent Central Bank
International Monetary Fund (IMF) - Research Department; Ecole Nationale des Ponts et Chaussees (ENPC); Centre for Economic Policy Research (CEPR)
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)
IMF Working Paper No. WP/04/162
An independent central bank can manage its balance sheet and its capital so as to commit itself to a depreciation of its currency and an exchange rate peg. This way, the central bank can implement the optimal escape from a liquidity trap, which involves a commitment to higher future inflation. This commitment mechanism works even though, realistically, the central bank cannot commit itself to a particular future money supply. It supports the feasibility of Svensson`s Foolproof Way to escape from a liquidity trap.
Number of Pages in PDF File: 44
Keywords: Zero lower bound for interest rates, deflation
JEL Classification: E52, F31, F41working papers series
Date posted: February 15, 2006
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