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

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  • Mr. Olivier D Jeanne
  • Mr. 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.

Suggested Citation

  • Mr. Olivier D Jeanne & Mr. Lars E. O. Svensson, 2004. "Credible Commitment to Optimal Escape from a Liquidity Trap: The Role of the Balance Sheet of an Independent Central Bank," IMF Working Papers 2004/162, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2004/162
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    References listed on IDEAS

    as
    1. Svensson, Lars-E-O, 2001. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 19(S1), pages 277-312, February.
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    More about this item

    Keywords

    WP; mover accent; Zero lower bound for interest rates; deflation; balance-sheet concern; price level; optimization problem; central-bank capital; budget constraint; output gap; Exchange rates; Liquidity; Inflation; Currencies; Capital adequacy requirements;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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