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

  • Olivier Jeanne
  • Lars E.O. Svensson

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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File URL: http://www.nber.org/papers/w10679.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10679.

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Date of creation: Aug 2004
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Publication status: published as 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.
Handle: RePEc:nbr:nberwo:10679
Note: EFG ME
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  1. Peter Stella, 1997. "Do Central Banks Need Capital?," IMF Working Papers 97/83, International Monetary Fund.
  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. 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.
  4. Lars E.O. Svensson, 2003. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 145-166, Fall.
  5. 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.
  6. Gauti B. Eggertsson, 2003. "How to Fight Deflation in a Liquidity Trap; Committing to Being Irresponsible," IMF Working Papers 03/64, International Monetary Fund.
  7. Christopher A. Sims, 2001. "Fiscal Aspects of Central Bank Independence," CESifo Working Paper Series 547, CESifo Group Munich.
  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. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 2001. "Currency crises and monetary policy in an economy with credit constraints," European Economic Review, Elsevier, vol. 45(7), pages 1121-1150.
  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.
  11. Peter Stella, 2002. "Central Bank Financial Strength, Transparency, and Policy Credibility," IMF Working Papers 02/137, International Monetary Fund.
  12. Edwin M. Truman, 2003. "Inflation Targeting in the World Economy," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 346.
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