The new-Keynesian liquidity trap

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Journal of Monetary Economics, ISSN: 0304-3932, Vol: 92, Page: 47-63

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John H. Cochrane
Elsevier BV
Economics, Econometrics and Finance
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article description
Many new-Keynesian models produce a deep recession with deflation at the zero bound. These models also make unusual policy predictions: Useless government spending, technical regress, capital destruction, and forward guidance can raise output. Moreover, these predictions are larger as prices become less sticky and as changes are expected further in the future. I show that these predictions are strongly affected by equilibrium selection. For the same interest-rate path, equilibria that bound initial jumps predict mild inflation, small output variation, negative multipliers, small effects of far-off expectations and a smooth frictionless limit. Fiscal policy considerations suggest the latter equilibria.