aaron, james lindsay, and pietro nivola ( eds. ), agenda for the nation ( the brookings institution, 2003 ). see also the general accounting office, truth and transparency : the federal government ’ s financial condition and fiscal outlook ( september 17, 2003 ) and rudolph g. penner and c. eugene steuerle, budget crisis at the door ( the urban institute, october 2003 ). see, for example, peter hooper, karen johnson, and jaime marquez, “ trade elasticities for g - 7 countries ”, princeton studies in international economics, vol. 87, ( august 2000 ). even this claim may be overoptimistic. see, for example, thomas laubach, “ new evidence on the interest rate effects of budget deficits and debt, ” finance and economics discussion series working paper ( april 2003 ). among other things, laubach has an interesting way to remove cyclical effects from his dependent variables, interest rates. portfolio shifts, perhaps even including increasing their stock of dollar - denominated debt. this denomination effect would not permanently prevent any relative price adjustment, but it could lengthen the process. beyond that, for pragmatic reasons this conventional adjustment process could be extended or distorted even further. by way of illustration, asian central banks have now accumulated more than a trillion dollars of international currency reserves - largely in dollar - denominated assets - equal to roughly half of the outstanding net debt of the united states. these central banks are not traditional wealth - holders motivated by expected risks and returns. instead, they seem motivated more by the prospect of preserving low domestic currency values for their exporters. 10 to pursue this objective, they can print money to buy u. s. securities. this monetary expansion could generate domestic inflation unless it is sterilized with other open market sales of securities - and the mere scale of present and expected future debt stocks may make continued sterilization impossible. but if these central banks continue behaving this way, the so - called credibility range could be extended significantly. while trade deficits should ultimately correct themselves, perhaps after a long trek through the credibility range, there are really no natural self - corrective mechanisms for budget deficits. once the u. s. economy gets through the credibility range, interest rates on the increasing government debt will have to rise to induce people to hold the debt. this rise increases the interest burden and causes total deficits to rise further, all the time subtracting

bound on nominal interest rates. these risks imply that undershooting a zero inflation objective is potentially more costly than overshooting that objective by the same amount, and that setting the inflation objective at a rate a bit above zero provides some insurance against these risks. downward nominal wage rigidities. inflation at rates close to zero might create nonnegligible costs to the economy because firms may be relatively reluctant to cut nominal wages. 7 sticky nominal wages can prevent labor markets from reaching the optimal equilibrium. however, empirical evidence from switzerland and japan indicates that in an environment of deflation or very low inflation, downward nominal wage rigidities become less prevalent. 8 debt deflation. keeping the average inflation rate close to zero increases the likelihood that the economy will experience occasional episodes of deflation. deflation can be particularly dangerous for an advanced economy, in which debt contracts often have long maturities. as described by irving fisher ( 1933 ), an episode of deflation can lead to " debt deflation, " that is, a substantial rise in the real indebtedness of households and firms, because the nominal values of debt obligations are largely predetermined whereas the nominal values of household income and business revenue are falling together with the general price level. 9 indeed, the deterioration of the balance sheets of households and firms can result in financial turmoil that contributes to further deflation and greater macroeconomic instability. the zero lower bound. with a very low average inflation rate, monetary policy is also more likely to encounter circumstances in which short - term interest rates are constrained by the so - called zero lower bound on nominal interest rates. 10 specifically, investors will never choose to lend money at a negative nominal interest rate because they always have the option of simply holding cash at a zero interest rate ; thus, nominal interest rates cannot fall below zero. a number of researchers in the federal reserve system and elsewhere have analyzed the implications of the zero lower bound in estimated dynamic rational expectations models. 11 if the economy faces a large contractionary shock, the optimal monetary policy response is to akerlof, dickens, and perry ( 2000 ). the main idea can be described as follows : during periods of low productivity growth and no inflation, firms that need to cut their relative wages can do so only by cutting money wages. in the presence of downward nominal wage rigidities, firms will keep relative wages too high and employment too low. hence, very low rates of inflation might prevent real wages from adjusting downward in response to declining