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

September 1, 2004

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

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.

Subject: Asset and liability management, Banking, Capital adequacy requirements, Currencies, Exchange rates, Financial regulation and supervision, Foreign exchange, Inflation, Liquidity, Money, Prices

Keywords: balance-sheet concern, budget constraint, Capital adequacy requirements, central-bank capital, Currencies, deflation, Exchange rates, Inflation, Liquidity, mover accent, optimization problem, output gap, price level, WP, Zero lower bound for interest rates

Pages:
44
Volume:
2004
DOI:
https://doi.org/10.5089/9781451857900.001
Issue:
162
Series:
Working Paper No. 2004/162
Stock No:
WPIEA1622004
ISBN:
9781451857900
ISSN:
1018-5941

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