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

  • Jeanne, Olivier
  • Svensson, Lars E O

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
Date of revision:
Handle: RePEc:cpr:ceprdp:4599
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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. Scott Roger & Mark R. Stone, 2005. "On Target? the International Experience with Achieving Inflation Targets," IMF Working Papers 05/163, International Monetary Fund.
  3. Auerbach, Alan J & Obstfeld, Maurice, 2004. "The Case for Open-Market Purchases in a Liquidity Trap," CEPR Discussion Papers 4447, C.E.P.R. Discussion Papers.
  4. Peter Stella, 2002. "Central Bank Financial Strength, Transparency, and Policy Credibility," IMF Working Papers 02/137, International Monetary Fund.
  5. Gauti B. Eggertsson, 2003. "How to Fight Deflation in a Liquidity Trap: Committing to Being Irresponsible," IMF Working Papers 03/64, International Monetary Fund.
  6. 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.
  7. Christopher A. Sims, 2001. "Fiscal Aspects of Central Bank Independence," CESifo Working Paper Series 547, CESifo Group Munich.
  8. 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.
  9. Edwin M. Truman, 2003. "Inflation Targeting in the World Economy," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 346.
  10. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
  11. Peter Stella, 1997. "Do Central Banks Need Capital?," IMF Working Papers 97/83, International Monetary Fund.
  12. 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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