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

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  • Stephanie Schmitt-Grohé
  • Martín Uribe

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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18544.

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Date of creation: Nov 2012
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Handle: RePEc:nbr:nberwo:18544

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  1. Shimer, Robert, 2012. "Wage rigidities and jobless recoveries," Journal of Monetary Economics, Elsevier, vol. 59(S), pages S65-S77.
  2. Alessandro Barattieri & Susanto Basu & Peter Gottschalk, 2010. "Some Evidence on the Importance of Sticky Wages," Boston College Working Papers in Economics 740, Boston College Department of Economics.
  3. Guillermo A. Calvo & Fabrizio Coricelli & Pablo Ottonello, 2012. "Labor Market, Financial Crises and Inflation: Jobless and Wageless Recoveries," NBER Working Papers 18480, National Bureau of Economic Research, Inc.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. The Making Of A Great Contraction With A Liquidity Trap and A Jobless Recovery
    by Christian Zimmermann in NEP-DGE blog on 2012-12-08 23:59:43
  2. Is it time for the Fed to raise its policy rate?
    by David Andolfatto in MacroMania on 2013-01-20 02:18:00
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Cited by:
  1. Zhen Huo & Jose-Victor Rios-Rull, 2012. "Engineering a paradox of thrift recession," Staff Report 478, Federal Reserve Bank of Minneapolis.
  2. Zhen Huo & Jose-Victor Rios-Rull, 2013. "Paradox of thrift recessions," Staff Report 490, Federal Reserve Bank of Minneapolis.
  3. 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.
  4. William T. Gavin & Benjamin D. Keen & Alexander Richter & Nathaniel Throckmorton, 2013. "Global dynamics at the zero lower bound," Working Papers 2013-007, Federal Reserve Bank of St. Louis.
  5. Leonardo Melosi & Francesco Bianchi, 2013. "Escaping the Great Recession," 2013 Meeting Papers 203, Society for Economic Dynamics.

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