How to Fight Deflation in a Liquidity Trap : Committing to Being Irresponsible

Author/Editor:

Gauti B. Eggertsson

Publication Date:

March 1, 2003

Electronic Access:

Free Download. Use the free Adobe Acrobat Reader to view this PDF file

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

I model deflation, at zero nominal interest rate, in a microfounded general equilibrium model. I show that deflation can be analyzed as a credibility problem if the government has only one policy instrument, money supply carried out by means of open market operations in short-term bonds, and cannot commit to future policies. I propose several policies to solve the credibility problem. They involve printing money or nominal debt and either (1) cutting taxes, (2) buying real assets such as stocks, or (3) purchasing foreign exchange. The government credibly "commits to being irresponsible" by using these policy instruments. It commits to higher money supply in the future so that the private sector expects inflation instead of deflation. This is optimal, since it curbs deflation and increases output by lowering the real rate of return.

Series:

Working Paper No. 03/64

Subject:

English

Publication Date:

March 1, 2003

ISBN/ISSN:

9781451848588/1018-5941

Stock No:

WPIEA0642003

Format:

Paper

Pages:

42

Please address any questions about this title to publications@imf.org