Working Papers

2013

 

July 2013, No. 13-07R

Contractionary Monetary Policy Caused the Great Recession in the Eurozone: A New Keynesian Perspective (Revised August 2014)

Robert L. Hetzel

The New Keynesian model limits the kinds of shocks that make optimal a trade-off by the central bank between inflation and an output gap. For shocks to preferences and technology, it should stick to an objective of price stability and allow the price system to work unhindered. One explanation for the Great Recession in the Eurozone is an inappropriate attempt by the ECB to create a negative output gap in response to a commodity-price (negative terms-of-trade) shock, which is like a negative technology shock.

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