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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. 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.
    2. 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.
    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. Bullard, James B., 2013. "Seven Faces of "The Peril"," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 613-628.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Schmidt, Sebastian, 2016. "Lack of confidence, the zero lower bound, and the virtue of fiscal rules," Journal of Economic Dynamics and Control, Elsevier, vol. 70(C), pages 36-53.
    2. Chattopadhyay, Siddhartha, 2019. "The Neo-Fisherianism to Escape Zero Lower Bound," MPRA Paper 92669, University Library of Munich, Germany.
    3. Robert Amano & Thomas J. Carter & Rhys R. Mendes, 2016. "A Primer on Neo-Fisherian Economics," Staff Analytical Notes 16-14, Bank of Canada.
    4. repec:aea:aecrev:v:107:y:2017:i:7:p:1971-2006 is not listed on IDEAS
    5. Martin, Christopher & Milas, Costas, 2013. "Financial crises and monetary policy: Evidence from the UK," Journal of Financial Stability, Elsevier, vol. 9(4), pages 654-661.
    6. Mariana Garcıa-Schmidt & Michael Woodford, "undated". "Are Low Interest Rates Deflationary? A Paradox of Perfect- Foresight Analysis," Working Papers Series 18, Institute for New Economic Thinking.
    7. Bilbiie, Florin Ovidiu, 2018. "Neo-Fisherian Policies and Liquidity Traps," CEPR Discussion Papers 13334, C.E.P.R. Discussion Papers.
    8. Lukmanova, Elizaveta & Rabitsch, Katrin, 2018. "New VAR evidence on monetary transmission channels: temporary interest rate versus inflation target shocks," Department of Economics Working Paper Series 6681, WU Vienna University of Economics and Business.
    9. Piotr Cizkowicz & Andrzej Rzonca & Andrzej Toroj, 2015. "In search for appropriate lower bound.Zero lower bound vs. positive lower bound under discretion and commitment," NBP Working Papers 215, Narodowy Bank Polski, Economic Research Department.
    10. Piotr Ciżkowicz & Andrzej Rzońca, 2015. "Inflation Targeting and its Discontents: The Case of Poland," Acta Oeconomica, Akadémiai Kiadó, Hungary, vol. 65(supplemen), pages 107-122, December.
    11. Piotr Ciżkowicz & Andrzej Rzońca, 2014. "Interest Rates Close to Zero, Post-crisis Restructuring and Natural Interest Rate," Prague Economic Papers, University of Economics, Prague, vol. 2014(3), pages 315-329.
    12. Rodríguez Arosemena, Nicolás, 2018. "The Dominium Mundi Game and the Case for Artificial Intelligence in Economics and the Law," MPRA Paper 90560, University Library of Munich, Germany.
    13. 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, vol. 9(2), pages 165-212, June.
    14. Dennis Bonam & Peter van Els & Jan Willem van den End & Leo de Haan & Irma Hindrayanto, 2018. "The natural rate of interest from a monetary and financial perspective," DNB Occasional Studies 1603, Netherlands Central Bank, Research Department.
    15. Duarte, Fernando M., 2016. "How to escape a liquidity trap with interest rate rules," Staff Reports 776, Federal Reserve Bank of New York, revised 01 Feb 2019.
    16. Gust, Christopher J. & Lopez-Salido, J. David & Smith, Matthew E. & Herbst, Edward, 2012. "The Empirical Implications of the Interest-Rate Lower Bound," Finance and Economics Discussion Series 2012-83, Board of Governors of the Federal Reserve System (US), revised Jan 2016.
    17. repec:aea:aecrev:v:109:y:2019:i:1:p:86-120 is not listed on IDEAS
    18. Richard G. Anderson, 2013. "Japan as a role model?," Economic Synopses, Federal Reserve Bank of St. Louis.

    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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