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Liquidity Traps: An Interest-Rate-Based Exit Strategy

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  • Stephanie Schmitt-Grohé
  • Martín Uribe

Abstract

This paper analyzes a potential strategy for escaping liquidity traps. The strategy is based on an augmented Taylor-type interest-rate feedback rule and differs from usual specifications in that when inflation falls below a threshold, the central bank temporarily deviates from the traditional Taylor rule by following a deterministic path for the nominal interest rate. This path reaches the intended target for this policy instrument in finite time. The policy we study is designed to raise inflationary expectations over time while at the same time maintaining all of the desirable local properties of the Taylor principle in a neighborhood of the intended inflation target. Importantly, the effectiveness of the potential exit strategy studied in this paper does not rely on the existence of an accompanying fiscalist (or non-Ricardian) fiscal stance.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16514.

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Date of creation: Nov 2010
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Publication status: published as
Handle: RePEc:nbr:nberwo:16514

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  1. Uribe, Martin, 1999. "Comparing the welfare costs and initial dynamics of alternative inflation stabilization policies," Journal of Development Economics, Elsevier, Elsevier, vol. 59(2), pages 295-318, August.
  2. James Bullard, 2010. "Seven faces of "the peril"," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 339-352.
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Cited by:
  1. Christopher Martin & Costas Milas, 2011. "Financial Crises and Monetary Policy: Evidence from the UK," Working Paper Series, The Rimini Centre for Economic Analysis 14_11, The Rimini Centre for Economic Analysis.
  2. Cizkowicz, Piotr & Rzonca, Andrzej, 2011. "Interest rates close to zero, post-crisis restructuring and natural interest rate," MPRA Paper 36989, University Library of Munich, Germany.
  3. Christopher Gust & David Lopez-Salido & Matthew E. Smith, 2012. "The empirical implications of the interest-rate lower bound," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2012-83, Board of Governors of the Federal Reserve System (U.S.).
  4. Richard G. Anderson, 2013. "Japan as a role model?," Economic Synopses, Federal Reserve Bank of St. Louis.
  5. Christiane Baumeister & Luca Benati, 2013. "Unconventional Monetary Policy and the Great Recession: Estimating the Macroeconomic Effects of a Spread Compression at the Zero Lower Bound," International Journal of Central Banking, International Journal of Central Banking, International Journal of Central Banking, vol. 9(2), pages 165-212, June.

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