Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others
Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others
Lars E.O. Svensson
JOURNAL OF ECONOMIC PERSPECTIVES
VOL. 17, NO. 4, FALL 2003
(pp. 145-166)
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Abstract
Existing proposals to escape from a liquidity trap and deflation, including my "Foolproof Way," are discussed in the light of the optimal way to escape. The optimal way involves three elements: (1) an explicit central-bank commitment to a higher future price level; (2) a concrete action that demonstrates the central bank's commitment, induces expectations of a higher future price level and jump-starts the economy; and (3) an exit strategy that specifies when and how to get back to normal. A currency depreciation is a direct consequence of expectations of a higher future price level and hence an excellent indicator of those expectations. Furthermore, an intentional currency depreciation and a crawling peg, as in the Foolproof Way, can implement the optimal way and, in particular, induce the desired expectations of a higher future price level. I conclude that the Foolproof Way is likely to work well for Japan, which is in a liquidity trap now, as well as for the euro area and the United States, in case either would fall into a liquidity trap in the future.
Citation
Svensson, Lars, EO. 2003. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others." Journal of Economic Perspectives, 17 (4): 145-166.
DOI: 10.1257/089533003772034934
JEL Classification
E31 Price Level; Inflation; Deflation
E32 Business Fluctuations; Cycles
E43 Interest Rates: Determination, Term Structure, and Effects
E52 Monetary Policy
E62 Fiscal Policy
F31 Foreign Exchange
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