The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap

Lars Svensson

No 2566, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: The paper examines the transmission mechanism of monetary policy in an open economy with and without a binding zero bound on nominal interest rates. In particular, a foolproof way of escaping from a liquidity trap is suggested, consisting of a price-level target path, a devaluation of the currency and a temporary exchange rate peg, which is later abandoned in favour of price-level or inflation targeting when the price-level target has been reached. This will jump-start the economy and escape deflation by a real depreciation of the domestic currency, a lower long real interest rate, and increased inflation expectations. The abandonment of the exchange-rate peg and the shift to price-level or inflation targeting will avoid the risk of overheating. Some conclusions for Japan are included.

Keywords: Deflation; Liquidity trap; Nominal interest rates (search for similar items in EconPapers)
JEL-codes: E52 F31 F33 F41 (search for similar items in EconPapers)
Date: 2000-09
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Citations: View citations in EconPapers (94)

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Related works:
Journal Article: The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap (2001)
Working Paper: The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap (2000)
Working Paper: The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap (2000)
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