Revisiting the New Keynesian policy paradoxes under QE

Bonciani, Dario and Oh, Joonseok (2023) Revisiting the New Keynesian policy paradoxes under QE. European Economic Review, 154, [104429]. (doi:10.1016/j.euroecorev.2023.104429).

Record type: Article

Abstract

Standard New Keynesian models deliver puzzling results at the effective lower bound of short-term interest rates: greater price flexibility amplifies the fall in the output gap in response to adverse demand shocks; labour tax cuts are contractionary; the multiplier of wasteful government spending is large. These outcomes stem from a failure to characterise monetary policy correctly. Both analytically and numerically, we show that allowing the central bank to respond to inflation with quantitative easing can resolve all these paradoxes. In quantitative terms, mild adjustments to the central bank’s balance sheet are sufficient to obtain results more in line with conventional wisdom.

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Accepted/In Press date: 10 March 2023

e-pub ahead of print date: 17 March 2023

Published date: 24 March 2023

Additional Information: Funding Information: We have particularly benefited from the detailed comments of the editor Florin Bilbiie and an anonymous referee. We are grateful to Cristiano Cantore, Ambrogio Cesa-Bianchi, Yongsung Chang, Sangyup Choi, Federico Di Pace, Yunjong Eo, Rodrigo Guimaraes, Wontae Han, Kuk Mo Jung, DongIk Kang, ShinHyuck Kang, Dong Heon Kim, Jinill Kim, Kwang Hwan Kim, Mira Kim, Soyoung Kim, Changsu Ko, Noh-Sun Kwark, Yoonsoo Lee, Eunseong Ma, Riccardo Masolo, Yeonu Oh, Evi Pappa, Marco Pinchetti, Ricardo Reis, Anna Rogantini Picco, Myungkyu Shim, Kwanho Shin, Eric Sims, Mathias Trabandt, Takayuki Tsuruga, Lutz Weinke, Lars Winkelmann, Donghoon Yoo, and an anonymous referee for the BoE Staff Working Paper for insightful discussions and helpful suggestions. All errors are our own. Publisher Copyright: © 2023

Keywords: Effective lower bound, Liquidity trap, Policy paradoxes, Quantitative easing, Unconventional monetary policy