Downward Wage Rigidity at the Zero Lower Bound

Abstract

This paper examines the role of downward nominal wage rigidity in deep recessions in a New Keynesian framework. We show that when the economy is in a liquidity trap and the nominal interest rate is constrained by the zero lower bound (ZLB), downward nominal wage rigidity reduces – rather than amplifies – the government spending multiplier. Furthermore, the multiplier does not rise with the duration of the ZLB. These findings depart from much of the conventional theoretical literature but help reconcile the gap between theory and empirical evidence.