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The Making Of A Great Contraction With A Liquidity Trap and A Jobless Recovery

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  • Schmitt-Grohé, Stephanie
  • Uribe, Martín
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    Abstract

    The great contraction of 2008 pushed the U.S. economy into a protracted liquidity trap (i.e., a long period with zero nominal interest rates and inflationary expectations below target). In addition, the recovery was jobless (i.e., output growth recovered but unemployment lingered). This paper presents a model that captures these three facts. The key elements of the model are downward nominal wage rigidity, a Taylor-type interest-rate feedback rule, the zero bound on nominal rates, and a confidence shock. Lack-of-confidence shocks play a central role in generating jobless recoveries, for fundamental shocks, such as disturbances to the natural rate, are shown to generate recessions featuring recoveries with job growth. The paper considers a monetary policy that can lift the economy out of the slump. Specifically, it shows that raising the nominal interest rate to its intended target for an extended period of time, rather than exacerbating the recession as conventional wisdom would have it, can boost inflationary expectations and thereby foster employment.

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    Bibliographic Info

    Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9237.

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    Date of creation: Dec 2012
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    Handle: RePEc:cpr:ceprdp:9237

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    Related research

    Keywords: Confidence shock; Jobless Recoveries; Liquidity Traps; Taylor Rule; Wage rigidity;

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    Cited by:
    1. Zhen Huo & José-Víctor Ríos-Rull, 2013. "Paradox of Thrift Recessions," NBER Working Papers 19443, National Bureau of Economic Research, Inc.
    2. Albinowski, Maciej & Ciżkowicz, Piotr & Rzońca, Andrzej, 2013. "Distrust in the ECB – product of failed crisis prevention or of inappropriate cure?," MPRA Paper 48242, University Library of Munich, Germany.

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