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Credible Commitment to Optimal Escape from a Liquidity Trap

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  • Olivier Jeanne
  • Lars E. O. Svensson

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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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 04/162.

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Length: 44
Date of creation: 01 Sep 2004
Date of revision:
Handle: RePEc:imf:imfwpa:04/162

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Related research

Keywords: Liquidity; Exchange rates; central bank; inflation; monetary policy; money supply; price level; monetary base; real interest rate; nominal interest rate; inflation rate; inflation target; foreign exchange; independent central bank; monetary fund; real money; low inflation; foreign currency; monetary liabilities; average inflation; inflation targeting; monetary aggregate; price stability; money demand; rational expectations; monetary instability; real value; macroeconomic stability; lower inflation; stock of money; monetary stability;

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References

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  1. 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.
  2. Alan Auerbach & Maurice Obstfeld, 2003. "The case for open-market purchases in a liquidity trap," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  3. Christopher A. Sims, 2001. "Fiscal Aspects of Central Bank Independence," CESifo Working Paper Series 547, CESifo Group Munich.
  4. Philippe Aghion & Philippe Bacchetta & Abhijit Banerjee, 2000. "Currency Crises and Monetary Policy in an Economy with Credit Constraints," Working Papers 00.07, Swiss National Bank, Study Center Gerzensee.
  5. 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.
  6. 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.
  7. Gauti B. Eggertsson, 2003. "How to Fight Deflation in a Liquidity Trap," IMF Working Papers 03/64, International Monetary Fund.
  8. Peter Stella, 1997. "Do Central Banks Need Capital?," IMF Working Papers 97/83, International Monetary Fund.
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Citations

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Cited by:
  1. Adam, Klaus & Billi, Roberto M., 2005. "Discretionary monetary policy and the zero lower bound on nominal interest rates," CFS Working Paper Series 2005/16, Center for Financial Studies (CFS).
  2. Gauti B. Eggertsson, 2006. "Fiscal multipliers and policy coordination," Staff Reports 241, Federal Reserve Bank of New York.
  3. Joshua Aizenman, 2010. "Comment on "Exporting Deflation? Chinese Exports and Japanese Prices"," NBER Chapters, in: China's Growing Role in World Trade, pages 227-230 National Bureau of Economic Research, Inc.
  4. Peter Stella & Åke Lonnberg, 2008. "Issues in central bank finance and independence," Working Paper 2008-13, Federal Reserve Bank of Atlanta.
  5. Fujiwara, Ippei & Hara, Naoko & Yoshimura, Kentaro, 2006. "Effectiveness of state-contingent monetary policy under a liquidity trap," Journal of the Japanese and International Economies, Elsevier, vol. 20(3), pages 364-379, September.
  6. Javier Gómez Pineda, . "A Framework for Macroeconomic Stability in Emerging Market Economies," Borradores de Economia 320, Banco de la Republica de Colombia.
  7. Okano, Eiji, 2007. "Inflation-output trade-offs in an optimization-based econometric framework applied to an open economy: The case of Japan," Journal of Asian Economics, Elsevier, vol. 18(1), pages 98-124, February.
  8. Gauti B. Eggertsson, 2005. "Great expectations and the end of the depression," Staff Reports 234, Federal Reserve Bank of New York.
  9. Javier Gómez Pineda, 2004. "A Framework for Macroeconomic Stability in Emerging Market Economies," BORRADORES DE ECONOMIA 001915, BANCO DE LA REPÚBLICA.
  10. Åke Lönnberg & Peter Stella, 2008. "Issues in Central Bank Finance and Independence," IMF Working Papers 08/37, International Monetary Fund.

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