I show that when a central bank is financially independent from the treasury and has
balance sheet concerns, an increase in the size or a change in the composition
of the central bank's balance sheet (quantitative easing) can serve as a commitment
device in a liquidity trap scenario. In particular, when the short-term interest rate is up
against the zero lower bound, an open market operation by the central bank that involves
purchases of long-term bonds can help mitigate the deation and a large negative output gap
under a discretionary equilibrium. This is because such an open market operation provides
an incentive to the central bank to keep interest rates low in future in order to avoid losses
in its balance sheet
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