This paper develops a general equilibrium model with putty‐clay technology, investment irreversibility, and variable capacity utilization. Low short‐run capital‐labor substitutability induces the putty‐clay effect of a tight link between changes in capacity and movements in employment and output. Permanent shocks to technology or factor prices generate a hump‐shaped response of hours, persistence in output growth, and positive comovement in the forecastable components of output and hours. Capacity constraints result in asymmetric responses to large shocks with recessions deeper than expansions. Estimation of a two‐sector model supports a significant role for putty‐clay capital in explaining business cycle and medium‐run dynamics.

The correlation between uncertainty shocks, as measured by changes in the VIX, and changes in break-even inflation rates declined and turned negative after the Great Recession. This estimated time-varying correlation is shown to be consistent with the predictions of a standard New Keynesian model with a lower bound on interest rates and a trend decline in the natural rate of interest. In one equilibrium of the model, higher uncertainty raises the probability of large shocks that leave the central bank constrained by the lower bound and unable to offset negative shocks. Resulting inflation shortfalls lower average inflation rates.

This paper analyzes the effects of the lower bound for interest rates on the distributions of inflation and interest rates. In a New Keynesian model with a lower bound, two equilibria emerge: policy is mostly unconstrained in the “target equilibrium,” whereas policy is mostly constrained in the “liquidity trap equilibrium.” Using options data on interest rates and inflation, we find forecast densities consistent with the target equilibrium and find no evidence in favor of the liquidity trap equilibrium. The lower bound has a sizable effect on the distribution of interest rates, but its impact on inflation is relatively modest.

The natural rate of interest—the real interest rate consistent with output equaling its natural rate and stable inflation—plays a central role in macroeconomic theory and monetary policy. Estimation of the natural rate of interest, however, has received little attention. We apply the Kalman filter to estimate jointly time-varying natural rates of interest and output and trend growth. We find a close link between the natural rate of interest and the trend growth rate, as predicted by theory. Estimates of the natural rate of interest, however, are very imprecise and subject to considerable real-time measurement error.

According to standard macroeconomic models, the zero lower bound greatly reduces the effectiveness of monetary policy and increases the efficacy of fiscal policy. However, private-sector decisions depend on the entire path of expected future short-term interest rates, not just the current short-term rate. Put differently, longer-term yields matter. We show how to measure the zero bound's effects on yields of any maturity. Indeed, 1- and 2-year Treasury yields were surprisingly unconstrained throughout 2008 to 2010, suggesting that monetary and fiscal policy were about as effective as usual during this period. Only beginning in late 2011 did these yields become more constrained.

We investigate the performance of forecast-based monetary policy rules using five macroeconomic models that reflect a wide range of views on aggregate dynamics. We identify the key characteristics of rules that are robust to model uncertainty; such rules respond to the one-year-ahead inflation forecast and to the current output gap and incorporate a substantial degree of policy inertia. In contrast, rules with longer forecast horizons are less robust and are prone to generating indeterminacy. Finally, we identify a robust benchmark rule that performs very well in all five models over a wide range of policy preferences.