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

  • Stephanie Schmitt-Grohé
  • Martín Uribe

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
Note: EFG ME
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  1. 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.
  2. 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.
  3. Shimer, Robert, 2012. "Wage rigidities and jobless recoveries," Journal of Monetary Economics, Elsevier, vol. 59(S), pages S65-S77.
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