Abstract: The standard new Keynesian models predicts that temporary, negative supply shocks are expansionary at the zero lower bound (ZLB) because they raise inflation expectations and lower expected real interest rates, which stimulates consumption. This paper tests that prediction with oil supply shocks and the Great East Japan earthquake, demonstrating that negative supply shocks are contractionary at the ZLB despite also lowering expected real interest rates. A model with borrowing-constrained agents can match these findings for certain parameters, but simultaneously eliminates the channel by which the standard new Keynesian model generates fiscal multipliers above 1.

Full paper can be found here.