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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.

Suggested Citation

  • Stephanie Schmitt-Grohé & Martín Uribe, 2012. "The Making Of A Great Contraction With A Liquidity Trap and A Jobless Recovery," NBER Working Papers 18544, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:18544
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    References listed on IDEAS

    as
    1. 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.
    2. Karel R. S. M. Mertens & Morten O. Ravn, 2014. "Fiscal Policy in an Expectations-Driven Liquidity Trap," Review of Economic Studies, Oxford University Press, vol. 81(4), pages 1637-1667.
    3. Calvo, Guillermo & Coricelli, Fabrizio & Ottonello, Pablo, 2012. "The Labor Market Consequences of Financial Crises With or Without Inflation: Jobless and Wageless Recoveries," CEPR Discussion Papers 9218, C.E.P.R. Discussion Papers.
    4. Alessandro Barattieri & Susanto Basu & Peter Gottschalk, 2014. "Some Evidence on the Importance of Sticky Wages," American Economic Journal: Macroeconomics, American Economic Association, vol. 6(1), pages 70-101, January.
    5. Shimer, Robert, 2012. "Wage rigidities and jobless recoveries," Journal of Monetary Economics, Elsevier, vol. 59(S), pages 65-77.
    Full references (including those not matched with items on IDEAS)

    Citations

    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 2012-12-09 05:59:43
    2. Is it time for the Fed to raise its policy rate?
      by David Andolfatto in MacroMania on 2013-01-20 08:18:00

    Citations

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    Cited by:

    1. Corsetti, G. & Mavroeidi, E. & Thwaites, G. & Wolf, M., 2016. "Step away from the zero lower bound: Small open economies in a world of secular stagnation," Cambridge Working Papers in Economics 1645, Faculty of Economics, University of Cambridge.
    2. Maciej Albinowski & Piotr Ciżkowicz & Andrzej Rzońca, 2014. "Links between trust in the ECB and its interest rate policy," Applied Economics, Taylor & Francis Journals, vol. 46(25), pages 3090-3106, September.
    3. Gianluca Benigno & Luca Fornaro, 2018. "Stagnation Traps," Review of Economic Studies, Oxford University Press, vol. 85(3), pages 1425-1470.
    4. 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 Dec 2016.
    5. Laurence Ball & Sandeep Mazumder, 2014. "A Phillips Curve with Anchored Expectations and Short-Term Unemployment," NBER Working Papers 20715, National Bureau of Economic Research, Inc.
    6. S Borağan Aruoba & Pablo Cuba-Borda & Frank Schorfheide, 2018. "Macroeconomic Dynamics Near the ZLB: A Tale of Two Countries," Review of Economic Studies, Oxford University Press, vol. 85(1), pages 87-118.
    7. Francesco Bianchi & Leonardo Melosi, 2017. "Escaping the Great Recession," American Economic Review, American Economic Association, vol. 107(4), pages 1030-1058, April.
    8. William T. Gavin & Benjamin D. Keen & Alexander W. Richter & Nathaniel A. Throckmorton, 2013. "Global Dynamics at the Zero Lower Bound," Auburn Economics Working Paper Series auwp2013-17, Department of Economics, Auburn University.
    9. Jordan Roulleau-Pasdeloup, 2016. "The Government Spending Multiplier in a Deep Recession," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 16.22, Université de Lausanne, Faculté des HEC, DEEP.
    10. Leonardo Melosi & Francesco Bianchi, 2017. "The Dire Effects of the Lack of Monetary and Fiscal Coordination," 2017 Meeting Papers 110, Society for Economic Dynamics.
    11. Jimeno, Juan F., 2015. "Long-lasting consequences of the European crisis," Working Paper Series 1832, European Central Bank.
    12. Vadym Lepetyuk & Lilia Maliar & Serguei Maliar, 2017. "Should Central Banks Worry About Nonlinearities of their Large-Scale Macroeconomic Models?," Staff Working Papers 17-21, Bank of Canada.
    13. 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.
    14. 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.
    15. Gavin, William T. & Keen, Benjamin D. & Richter, Alexander W. & Throckmorton, Nathaniel A., 2015. "The zero lower bound, the dual mandate, and unconventional dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 55(C), pages 14-38.
    16. Holden, Tom D., 2016. "Existence, uniqueness and computation of solutions to dynamic models with occasionally binding constraints," EconStor Preprints 127430, ZBW - Leibniz Information Centre for Economics.
    17. Zhen Huo & Jose-Victor Rios-Rull, 2013. "Paradox of thrift recessions," Staff Report 490, Federal Reserve Bank of Minneapolis.
    18. Roos Michael W. M., 2015. "Die Komplexitätsökonomik und ihre Implikationen für die Wirtschaftspolitik," Perspektiven der Wirtschaftspolitik, De Gruyter, vol. 16(4), pages 379-392, December.
    19. 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.
    20. Piero Ferri & Annalisa Cristini & Anna Maria Variato, 2016. "Endogenous fluctuations, markups, capacity and credit constraints," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 11(2), pages 273-292, October.
    21. repec:eee:reveco:v:55:y:2018:i:c:p:54-67 is not listed on IDEAS
    22. Lasitha R.C. Pathberiya, 2018. "Jobless Recovery, Liquidity Trap, Tight Monetary Policy and the Cost Channel," Discussion Papers Series 591, School of Economics, University of Queensland, Australia.
    23. Holden, Thomas, 2016. "Existence and uniqueness of solutions to dynamic models with occasionally binding constraints," EconStor Preprints 130142, ZBW - Leibniz Information Centre for Economics.
    24. Zhen Huo & Jose-Victor Rios-Rull, 2012. "Engineering a paradox of thrift recession," Staff Report 478, Federal Reserve Bank of Minneapolis.
    25. Duarte, Fernando M. & Zabai, Anna, 2015. "An interest rate rule to uniquely implement the optimal equilibrium in a liquidity trap," Staff Reports 745, Federal Reserve Bank of New York.

    More about this item

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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