Working Paper: NBER ID: w18544
Authors: 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.
Keywords: No keywords provided
JEL Codes: E24; E31; E32; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| lack of confidence shock (D80) | decrease in inflationary expectations (E31) |
| decrease in inflationary expectations (E31) | rise in real wages above full employment level (J39) |
| rise in real wages above full employment level (J39) | involuntary unemployment (J64) |
| lack of confidence shock (D80) | involuntary unemployment (J64) |
| inflationary expectations not anchored (E31) | Taylor rule response to falling inflation validates agents' expectations of future deflation (E31) |
| Taylor rule response to falling inflation (E31) | perpetuating unemployment (J68) |
| well anchored inflationary expectations (E31) | fundamental shocks lead to recoveries with output growth and job creation (E32) |
| confidence shocks (D83) | jobless recoveries (J64) |
| raising nominal interest rates in a confidence shock-induced liquidity trap (E43) | boost inflationary expectations and foster employment (E31) |
| downward nominal wage rigidity and the Taylor rule (E31) | crucial mechanisms in dynamics (C69) |