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American Economic Review: Vol. 97 No. 1 (March 2007)

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

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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Jeanne, Olivier
Svensson, Lars E. O.


American Economic Review


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