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Liquidity Traps: an Interest-rate-based Exit Strategy

Author

Listed:
  • Stephanie Schmitt-Grohé
  • Martín Uribe

Abstract

This paper proposes a strategy for escaping liquidity traps based on an augmented Taylor-type interest-rate feedback rule that 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 that reaches the intended target for this policy instrument in finite time. The proposed policy is designed to set a floor on inflationary expectations. Importantly, the effectiveness of the proposed exiting strategy does not rely on the existence of an accompanying fiscalist (or non-Ricardian) fiscal stance.

Suggested Citation

  • Stephanie Schmitt-Grohé & Martín Uribe, 2014. "Liquidity Traps: an Interest-rate-based Exit Strategy," Manchester School, University of Manchester, vol. 82(S1), pages 1-14, September.
    • Handle: RePEc:bla:manchs:v:82:y:2014:i:s1:p:1-14
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    File URL: http://hdl.handle.net/10.1111/manc.12065
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    References listed on IDEAS

    as
    1. Uribe, Martin, 1999. "Comparing the welfare costs and initial dynamics of alternative inflation stabilization policies," Journal of Development Economics, Elsevier, vol. 59(2), pages 295-318, August.
    2. James B. Bullard, 2013. "Seven Faces of \\"The Peril\\"," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 613-628.
    3. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Avoiding Liquidity Traps," Journal of Political Economy, University of Chicago Press, vol. 110(3), pages 535-563, June.
    4. Benhabib, Jess & Schmitt-Grohe, Stephanie & Uribe, Martin, 2001. "The Perils of Taylor Rules," Journal of Economic Theory, Elsevier, vol. 96(1-2), pages 40-69, January.
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    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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