Liquidity Traps: An Interest‐Rate‐Based Exit Strategy

14 Pages Posted: 22 Aug 2014

See all articles by Stephanie Schmitt-Grohé

Stephanie Schmitt-Grohé

Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Martín Uribe

Columbia University - Graduate School of Arts and Sciences - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: September 2014

Abstract

This paper proposes a strategy for escaping liquidity traps based on an augmented Taylor‐type interest‐rate feedback rule that 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 that reaches the intended target for this policy instrument in finite time. The proposed policy is designed to set a floor on inflationary expectations. Importantly, the effectiveness of the proposed exiting strategy does not rely on the existence of an accompanying fiscalist (or non‐Ricardian) fiscal stance.

Suggested Citation

Schmitt-Grohe, Stephanie and Uribe, Martin, Liquidity Traps: An Interest‐Rate‐Based Exit Strategy (September 2014). The Manchester School, Vol. 82, pp. 1-14, 2014, Available at SSRN: https://ssrn.com/abstract=2484871 or http://dx.doi.org/10.1111/manc.12065

Stephanie Schmitt-Grohe (Contact Author)

Centre for Economic Policy Research (CEPR) ( email )

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United Kingdom

National Bureau of Economic Research (NBER)

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Martin Uribe

Columbia University - Graduate School of Arts and Sciences - Department of Economics ( email )

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