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Liquidity Traps: An Interest-Rate-Based Exit Strategy

  • Stephanie Schmitt-Grohé
  • Martín Uribe

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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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
Date of revision:
Handle: RePEc:nbr:nberwo:16514
Note: EFG ME
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  1. Bullard, James B., 2013. "Seven Faces of "The Peril"," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 613-628.
  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.
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