Title: Escaping from a liquidity trap and deflation
First published: 2003
Description: "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"--National Bureau of Economic Research web site.
Subjects: Econometric models, Interest rates, Liquidity (Economics), Deflation (Finance)
LC classification: HB1