DP11966 | A Central Bank Theory of Price Level Determination

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04/18/2017

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Abstract

The remittances’ policy and the balance sheet of the central bank are important elements to specify for the control of the price level. A central bank appropriately capitalized can succeed to control prices by setting the interest rate on reserves, holding risk-free assets and rebating its income to the treasury - from which it has to maintain financial independence. If the central bank undertakes unconventional open-market operations, either it has to give up its financial independence or leaves the economy exposed to self-fulfilling inflationary spirals or chronic liquidity traps.