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Jobless Recovery, Liquidity Trap, Tight Monetary Policy and the Cost Channel

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  • Lasitha R.C. Pathberiya

    (Central Bank of Sri Lanka
    School of Economics, The University of Queensland)

Abstract

In this study, I examine the robustness of an unconventional monetary policy in a cost channel economy. The unconventional monetary policy proposed by Schmitt-Grohé and Uribe (2017, American Economic Journal: Macroeconomics, SGU henceforth), recommends a tight monetary policy during a liquidity-trapped recession to stimulate the economy and to avoid jobless recovery. The results of my study show that the existence of the cost channel implies that the SGU policy induces sharp initial contractions in the employment rate and the growth rate, and a sharp increase in inflation following a negative confidence shock. Welfare is lower in cost channel economies compared to no-cost channel economies due to the SGU policy recommendation. Two alternative interest rate-based exit policies are also examined. The Overshoot interest rate policy, irrespective of the presence of the cost channel, is superior to the SGU policy with regard to welfare. The Staggered policy has lower immediate pain in the cost channel economy compared to the SGU policy or the Overshoot policy. However, welfare-wise, the Staggered policy is inferior to the other two policies examined in both economies considered.

Suggested Citation

  • 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.
  • Handle: RePEc:qld:uq2004:591
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    File URL: http://www.uq.edu.au/economics/abstract/591.pdf
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    References listed on IDEAS

    as
    1. Luc Laeven & Fabián Valencia, 2013. "The Real Effects of Financial Sector Interventions during Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(1), pages 147-177, February.
    2. McCallum, Andrew & Smets, Frank, 2007. "Real wages and monetary policy transmission in the euro area," Kiel Working Papers 1360, Kiel Institute for the World Economy (IfW).
    3. Schmitt-Grohé, Stephanie & Uribe, Martín, 2012. "The Making Of A Great Contraction With A Liquidity Trap and A Jobless Recovery," CEPR Discussion Papers 9237, C.E.P.R. Discussion Papers.
    4. Shimer, Robert, 2012. "Wage rigidities and jobless recoveries," Journal of Monetary Economics, Elsevier, vol. 59(S), pages 65-77.
    5. 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.
    6. Stephanie Schmitt-Grohé & Martin Uribe, 2013. "Downward Nominal Wage Rigidity and the Case for Temporary Inflation in the Eurozone," Journal of Economic Perspectives, American Economic Association, vol. 27(3), pages 193-212, Summer.
    7. Robert E. Lucas Jr., 2003. "Macroeconomic Priorities," American Economic Review, American Economic Association, vol. 93(1), pages 1-14, March.
    8. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 199-216, March.
    9. Stephanie Schmitt-Grohé & Martín Uribe, 2017. "Liquidity Traps and Jobless Recoveries," American Economic Journal: Macroeconomics, American Economic Association, vol. 9(1), pages 165-204, January.
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Jobless Recovery, Liquidity Trap, Tight Monetary Policy and the Cost Channel
      by Christian Zimmermann in NEP-DGE blog on 2018-06-16 17:52:46

    More about this item

    Keywords

    cost channel of monetary policy; zero rates on interest rates; liquidity trap; jobless recovery; downward nominal wage rigidity; Taylor rule;

    JEL classification:

    • 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
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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