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Credible Commitment to Optimal Escape from a Liquidity Trap: The Role of the Balance Sheet of an Independent Central Bank

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  • Jeanne, Olivier
  • Svensson, Lars E O

Abstract

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.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4599.

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Date of creation: Sep 2004
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Handle: RePEc:cpr:ceprdp:4599

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Keywords: deflation; zero lower bound for interest rates;

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  1. Auerbach, Alan J. & Obstfeld, Maurice, 2012. "The Case for Open-Market Purchases in a Liquidity Trap," Center for International and Development Economics Research, Working Paper Series qt4tm5h0s3, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
  2. Lars E.O. Svensson, 2003. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others," NBER Working Papers 10195, National Bureau of Economic Research, Inc.
  3. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 2000. "Currency Crises and Monetary Policy in an Economy with Credit Constraints," CEPR Discussion Papers 2529, C.E.P.R. Discussion Papers.
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  6. John Hawkins, 2003. "Central bank balance sheets and fiscal operations," BIS Papers chapters, in: Bank for International Settlements (ed.), Fiscal issues and central banking in emerging economies, volume 20, pages 71-83 Bank for International Settlements.
  7. Edwin M. Truman, 2003. "Inflation Targeting in the World Economy," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 346.
  8. Scott Roger & Mark R. Stone, 2005. "On Target? the International Experience with Achieving Inflation Targets," IMF Working Papers 05/163, International Monetary Fund.
  9. Peter Stella, 2002. "Central Bank Financial Strength, Transparency, and Policy Credibility," IMF Working Papers 02/137, International Monetary Fund.
  10. Grilli, Vittorio U., 1986. "Buying and selling attacks on fixed exchange rate systems," Journal of International Economics, Elsevier, vol. 20(1-2), pages 143-156, February.
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  12. Peter Stella, 1997. "Do Central Banks Need Capital?," IMF Working Papers 97/83, International Monetary Fund.
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