Working Paper: CEPR ID: DP4599
Authors: Olivier Jeanne; 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.
Keywords: Deflation; Zero Lower Bound for Interest Rates
JEL Codes: E52; F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Independent Central Bank's balance sheet management (E58) | Higher future price level (E30) |
| Independent Central Bank's balance sheet management (E58) | Higher future inflation (E31) |
| Weaker currency (F31) | Higher future price level (E30) |
| Weaker currency (F31) | Higher future inflation (E31) |
| Central Bank's capital management (E58) | Credibility of future inflation expectations (E31) |
| Central Bank's capital management (E58) | Escape from liquidity trap (E49) |
| Higher future price level (E30) | Higher future inflation (E31) |