DP4599 Credible Commitment to Optimal Escape from a Liquidity Trap: The Role of the Balance Sheet of an Independent Central Bank

Author(s): Olivier Jeanne , Lars E O Svensson

Publication Date: September 2004

Keyword(s): zero lower bound for interest rates , deflation

JEL(s): E52 , F31 , F41

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP4599.asp

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.