Yes, Virginia, a central bank can always stimulate the economy if it wants to
Having studied mostly philosophy, I certainly can’t claim to be able to prove the above proposition because I simply don’t know the full intricacies of rational expectations economics (although I would love to). But what I can do is monitor the assertions of both sides for internal and empirical consistency. On that note, here is what the eminent economist Paul Krugman (he who coined the ‘expectations trap’) wrote in June of last year in the course of denying Scott Sumner’s claim that there are always foolproof methods available to a central bank to inflate/stimulate:
The Swiss National Bank has been trying hard to prevent an appreciation of the franc: since the start of the crisis Switzerland has added around $100 billion, or 20% of GDP, to its foreign exchange reserves. An equivalent intervention for the US would be $3.5 trillion. Yet the franc has still strengthened from .6 to .7 euro
And here is what happened after the Swiss National Bank announced an explicit exchange rate floor, which if Sumner is right would make all the difference to the policy’s success (from The Street Light, via Lars Christensen):
You may recall that in September the Swiss National Bank (SNB) announced that it was going to intervene as necessary in the currency markets to ensure that the Swiss Franc (CHF) stayed above a minimum exchange rate with the euro of 1.20 CHF/EUR. How has that been working out for them?
It turns out that it has been working extremely well. Today the SNB released data on its balance sheet for the end of September. During the month of August the SNB had to spend almost CHF 100 billion to buy foreign currency assets to keep the exchange rate at a reasonable level. But in September — most of which was after the announcement of the exchange rate minimum — the SNB’s foreign currency assets only grew by about CHF 25 billion. Furthermore, this increase in the CHF value of the SNB’s foreign currency assets likely includes substantial capital gains that the SNB reaped on its euro portfolio (which was valued at about €130 bn at the end of September), as the CHF was almost 10% weaker against the euro in September than in August. Given that, it seems likely that the SNB’s purchases of new euro assets in September after the announcement of the exchange rate floor almost completely stopped.
Draw your own conclusions.