The way to make monetary policy effective, then, is for the central bank to credibly promise to be irresponsible - to make a persuasive case that it will permit inflation to occur, thereby producing the negative real interest rates the economy needs.This sounds funny as well as perverse. Bear in mind, however, that the basic premise - that even a zero nominal interest rate is not enough to produce sufficient aggregate demand - is not hypothetical: it is a simple fact about Japan right now. Unless one can make a convincing case that structural reform or fiscal expansion will provide the necessary demand, the only way to expand the economy is to reduce the real interest rate; and the only way to do that is to create expectations of inflation.Of course, it is not necessary that Japan do anything. In the quasi-static IS-LM version of the liquidity trap, it appears as if the slump could go on forever. A dynamic analysis makes it clear that it is a temporary phenomenon - in the model it only lasts one period, although the length of a "period" is unclear (it could be three years, or it could be 20). Even without any policy action, price adjustment or spontaneous structural change will eventually solve the problem. In the long run Japan will work its way out of the trap, whatever the policy response. But on the other hand, in the long run ...
He states that the problem will fix itself eventually, correct. So how does the central bank have any credibility under the circumstance? If their system is forcing double entry accounting, then the charts tell everyone to wait.
If they want to credibly hurry things up, they have to tell the truth:
We never get to infinity, we engage in partial default first, and that is the truth. It is also a mathematically fact for any aggregate system without infinite energy. There will be quite the censorship and shading of data for Keynesians to pull off another stimulus, we already know it is ineffective and we are hit with the debt costs indefinitely.
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