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  4. March 2007
  5. Credible Commitment to Optimal Escape from a Liquidity Trap: The Role of the Balance Sheet of an Independent Central Bank

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

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

  • Olivier Jeanne
  • Lars E. O. Svensson
American Economic Review
vol. 97, no. 1, March 2007
(pp. 474–490)
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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)

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

JEL Classification

  • E52 Monetary Policy
  • E58 Central Banks and Their Policies