Liquidity Traps and Jobless Recoveries

This paper proposes a model that explains the joint occurrence of liquidity traps and jobless growth recoveries. Its key elements are downward nominal wage rigidity, a Taylor-type interest rate feedback rule, the zero lower bound on nominal interest rates, and a confidence shock. Absent a change in policy, the model predicts that low inflation and high unemployment become chronic. With capital accumulation, the model predicts, in addition, an investment slump. The paper identifies a New Fisherian effect, whereby raising the nominal interest rate to its intended target for an extended period of time can boost inflationary expectations and thereby foster employment.