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What Good is Higher Inflation? To Avoid or Escape the liquidity Trap

  • Croitoru, Lucian

    (NBR, Romania)

on reflating the economy in order to release it from the liquidity trap. We show that the following problems may arise in this context: linking inflation expectations to base money developments; increased uncertainty on the possible reversal of quantitative easing by central banks in close correlation with banks’ lower liquidity preference after escaping the liquidity trap; higher inflation when central banks fail to reverse the quantitative easing at an adequate pace for a long period; losses reported by central banks once economies exit the liquidity trap and yields go up. Given the recurrence of the instability cycle and the higher probability of the economy to avoid falling into the liquidity trap if inflation is relatively high when a bubble bursts, then such inflation is preferable to a relatively low one. This paper proposes an enhancement of the monetary policy objective by shifting from explicit or implicit targeting of low and stable inflation to targeting moderate and stable inflation.

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Article provided by Institute for Economic Forecasting in its journal Romanian Journal for Economic Forecasting.

Volume (Year): (2013)
Issue (Month): 3 (October)
Pages: 5-25

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Handle: RePEc:rjr:romjef:v::y:2013:i:3:p:5-25
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  1. Giovanni Dell'Ariccia & Olivier J. Blanchard & Paolo Mauro, 2010. "Rethinking Macroeconomic Policy," IMF Staff Position Notes 2010/03, International Monetary Fund.
  2. Mertens, Karel & Ravn, Morten O, 2010. "Fiscal Policy in an Expectations Driven Liquidity Trap," CEPR Discussion Papers 7931, C.E.P.R. Discussion Papers.
  3. Alan Auerbach & Maurice Obstfeld, 2004. "The Case for Open-Market Purchases in a Liquidity Trap," Macroeconomics 0407009, EconWPA.
  4. Woodford Michael, 2002. "Inflation Stabilization and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, vol. 2(1), pages 1-53, February.
  5. McCallum, Bennett T & Nelson, Edward, 1999. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 296-316, August.
  6. Olivier Blanchard & Jordi Galí, 2010. "Labor Markets and Monetary Policy: A New Keynesian Model with Unemployment," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(2), pages 1-30, April.
  7. Marvin Goodfriend, 2000. "Overcoming the zero bound on interest rate policy," Working Paper 00-03, Federal Reserve Bank of Richmond.
  8. Steve Keen, 1995. "Finance and Economic Breakdown: Modeling Minsky's "Financial Instability Hypothesis"," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 17(4), pages 607-635, July.
  9. Ben S. Bernanke & Vincent R. Reinhart, 2004. "Conducting Monetary Policy at Very Low Short-Term Interest Rates," American Economic Review, American Economic Association, vol. 94(2), pages 85-90, May.
  10. Olivier Jeanne & Lars E. O. Svensson, 2007. "Credible Commitment to Optimal Escape from a Liquidity Trap: The Role of the Balance Sheet of an Independent Central Bank," American Economic Review, American Economic Association, vol. 97(1), pages 474-490, March.
  11. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
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