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AER - Previous Issues
 AER - March 2007

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American Economic Review

Vol. 97, No. 1, March 2007

Credible Commitment to Optimal Escape from a Liquidity Trap: The Role of the Balance Sheet of an Independent Central Bank
Olivier Jeanne and Lars E. O. Svensson

Article Citation
Jeanne, Olivier, and 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, 97(1): 474–490.
DOI:10.1257/aer.97.1.474

Abstract
Central banks target CPI inflation; independent central banks are concerned about their balance sheet and the level of their capital. The first fact makes it difficult for a central bank to implement the optimal escape from a liquidity trap, because it undermines a commitment to overshoot the inflation target. We show that the second fact provides a solution. Capital concerns provide a mechanism for an independent central bank to commit to inflate ex post. The optimal policy can take the form of a currency depreciation combined with a crawling peg, a policy advocated by Svensson as the "Foolproof Way" to escape from a liquidity trap. (JEL E31, E52, E58, E62)

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Authors
Jeanne, Olivier
Svensson, Lars E. O.