Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others

Lars Svensson

No 10195, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: E52 F31 (search for similar items in EconPapers)
Date: 2003-12
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mac and nep-mon
Note: IFM ME
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (275)

Published as Svensson, Lars O. "Escaping From A Liquidity Trap And Deflation: The Foolproof Way And Others," Journal of Economic Perspectives, 2003, v17(4,fall), 145-166.

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