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How to Fight Deflation in a Liquidity Trap; Committing to Being Irresponsible

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  • Gauti B. Eggertsson

Abstract

I model deflation, at zero nominal interest rate, in a microfounded general equilibrium model. I show that deflation can be analyzed as a credibility problem if the government has only one policy instrument, money supply carried out by means of open market operations in short-term bonds, and cannot commit to future policies. I propose several policies to solve the credibility problem. They involve printing money or nominal debt and either (1) cutting taxes, (2) buying real assets such as stocks, or (3) purchasing foreign exchange. The government credibly "commits to being irresponsible" by using these policy instruments. It commits to higher money supply in the future so that the private sector expects inflation instead of deflation. This is optimal, since it curbs deflation and increases output by lowering the real rate of return.

Suggested Citation

  • Gauti B. Eggertsson, 2003. "How to Fight Deflation in a Liquidity Trap; Committing to Being Irresponsible," IMF Working Papers 03/64, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:03/64
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    1. Return of Undergraduate Macro?
      by CV in Alpha.Sources.CV on 2013-10-07 13:07:13

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    Cited by:

    1. Adam, Klaus & Billi, Roberto M., 2006. "Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(7), pages 1877-1905, October.
    2. João Braz Pinto & João Sousa Andrade, 2015. "A Monetary Analysis of the Liquidity Trap," GEMF Working Papers 2015-06, GEMF, Faculty of Economics, University of Coimbra.
    3. Iwamoto, Yasushi, 2005. "Monetary and Fiscal Policy to Escape from a Deflationary Trap," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 23(1), pages 1-46, February.
    4. 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.
    5. Alan J. Auerbach & Maurice Obstfeld, 2005. "The Case for Open-Market Purchases in a Liquidity Trap," American Economic Review, American Economic Association, vol. 95(1), pages 110-137, March.
    6. Günter Coenen & Volker W. Wieland, 2004. "Exchange-Rate Policy and the Zero Bound on Nominal Interest Rates," American Economic Review, American Economic Association, vol. 94(2), pages 80-84, May.
    7. Junning Cai, 2004. "Liquidity Trap Prevention and Escape: A Simple Proposition," Macroeconomics 0402033, University Library of Munich, Germany.
    8. Roland Döhrn & György Barabas & Heinz Gebhardt & Tobias Kitlinksi & Martin Micheli & Simeon Vosen & Lina Zwick, 2013. "Die wirtschaftliche Entwicklung im Inland: Binnennachfrage trägt Aufschwung," RWI Konjunkturbericht, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, pages 64, 09.
    9. Fernando M. Gonçalves, 2008. "Accumulating Foreign Reserves Under Floating Exchange Rates," IMF Working Papers 08/96, International Monetary Fund.
    10. Frederic S. Mishkin, 2005. "The Fed after Greenspan," Eastern Economic Journal, Eastern Economic Association, vol. 31(3), pages 317-332, Summer.
    11. Gauti B. Eggertsson & Kevin B. Proulx, 2016. "Bernanke’s No-Arbitrage Argument Revisited: Can Open Market Operations in Real Assets Eliminate the Liquidity Trap?," Central Banking, Analysis, and Economic Policies Book Series,in: Elías Albagli & Diego Saravia & Michael Woodford (ed.), Monetary Policy through Asset Markets: Lessons from Unconventional Measures and Implications for an Integrated World, edition 1, volume 24, chapter 3, pages 063-104 Central Bank of Chile.
    12. Girardin, Eric & Moussa, Zakaria, 2011. "Quantitative easing works: Lessons from the unique experience in Japan 2001â2006," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 21(4), pages 461-495, October.
    13. Cees Ullersma & Gerben Hieminga, 2006. "Note on zero lower bound worries," DNB Working Papers 117, Netherlands Central Bank, Research Department.
    14. Shigeru Iwata, 2010. "Monetary Policy and the Term Structure of Interest Rates When Short-Term Rates Are Close to Zero," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 28, pages 59-78, November.
    15. Piotr Cizkowicz & Andrzej Rzonca & Andrzej Toroj, 2015. "In search for appropriate lower bound.Zero lower bound vs. positive lower bound under discretion and commitment," NBP Working Papers 215, Narodowy Bank Polski, Economic Research Department.
    16. Mark R. Stone & Charles Frederick Kramer, 2005. "A Post-Reflation Monetary Framework for Japan," IMF Working Papers 05/73, International Monetary Fund.
    17. James Harrigan & Kenneth Kuttner, 2004. "Lost Decade in Translation: Did the US Learn from Japan's Post-Bubble Mistakes?," NBER Working Papers 10938, National Bureau of Economic Research, Inc.
    18. Gauti B. Eggertsson & Eric Le Borgne, 2005. "The politics of central bank independence: a theory of pandering and learning in government," Staff Reports 205, Federal Reserve Bank of New York.
    19. Eric Le Borgne & Gauti B. Eggertsson, 2007. "Dynamic Incentives and the Optimal Delegation of Political Power," IMF Working Papers 07/91, International Monetary Fund.
    20. Willem H. Buiter, 2003. "Helicopter Money: Irredeemable Fiat Money and the Liquidity Trap," NBER Working Papers 10163, National Bureau of Economic Research, Inc.
    21. Döhrn, Roland & Barabas, György & Gebhardt, Heinz & Kitlinski, Tobias & Micheli, Martin & Vosen, Simeon & Zwick, Lina, 2013. "Die wirtschaftliche Entwicklung im Inland: Binnennachfrage trägt Aufschwung," RWI Konjunkturberichte, RWI - Leibniz-Institut für Wirtschaftsforschung, vol. 64(3), pages 41-103.
    22. Mark R. Stone, 2003. "Greater Monetary Policy Transparency for the G3; Lessons From Full-Fledged Inflation Targeters," IMF Working Papers 03/218, International Monetary Fund.
    23. Kuttner, Kenneth-N, 2004. "Comments on "Price Stability and Japanese Monetary Policy."," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 22(3), pages 37-46, October.
    24. Klaus Adam, 2004. "Monetary Policy in a Low Inflation Environment," Research Bulletin, European Central Bank, vol. 1, pages 6-7.

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    Keywords

    Deflation; Monetary policy; liquidity traps; zero bound on nominal interest rates; inflation; money supply; central bank; nominal interest rate; zero bound on nominal rates;

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