Theory in practice : the implementation of the foolproof way in Switzerland and the Czech Republic

Abstract

We analyse the similarities between the Svensson’s (2000) “The zero bound in an open economy: A foolproof way of escaping from a liquidity trap” and the exchange rate target commitment implemented in Switzerland and the Czech Republic following the European sovereign debt crisis. We observe that the foolproof way did not work in Switzerland, mainly due to failure to establish the peg’s credibility. This is linked to the existence of incomplete pass-through, a feature not contemplated in Svensson’s model. On the other hand, we conclude that the foolproof way succeed in the Czech Republic, allowing the economy to escape the liquidity trap.