Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others

24 Pages Posted: 4 Jan 2004 Last revised: 11 Nov 2022

See all articles by Lars E. O. Svensson

Lars E. O. Svensson

Stockholm School of Economics; Stockholm University - Institute for International Economic Studies (IIES); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: December 2003

Abstract

Existing proposals to escape from a liquidity trap and deflation, including my Foolproof Way,' are discussed in the light of the optimal way to escape. The optimal way involves three elements: (1) an explicit central-bank commitment to a higher future price level; (2) a concrete action that demonstrates the central bank's commitment, induces expectations of a higher future price level and jump-starts the economy; and (3) an exit strategy that specifies when and how to get back to normal. A currency depreciation is a direct consequence of expectations of a higher future price level and hence an excellent indicator of those expectations. Furthermore, an intentional currency depreciation and a crawling peg, as in the Foolproof Way, can implement the optimal way and, in particular, induce the desired expectations of a higher future price level. I conclude that the Foolproof Way is likely to work well for Japan, which is in a liquidity trap now, as well as for the euro area and the United States, in case either would fall into a liquidity trap in the future.

Suggested Citation

Svensson, Lars E.O., Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others (December 2003). NBER Working Paper No. w10195, Available at SSRN: https://ssrn.com/abstract=483126

Lars E.O. Svensson (Contact Author)

Stockholm School of Economics ( email )

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HOME PAGE: http://larseosvensson.se

Stockholm University - Institute for International Economic Studies (IIES) ( email )

Stockholm, SE-10691
Sweden

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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