Journal of Economic Perspectives
ISSN 0895-3309 (Print) | ISSN 1944-7965 (Online)
Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others
Journal of Economic Perspectives
(pp. 145–166)
(Complimentary)
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: 10.1257/089533003772034934JEL 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