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Division of International Finance. Board of Governors of the Federal Reserve System. Washington, D.C. 20551.

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This paper studies aggregate dynamics near the zero lower bound (ZLB) of nominal interest rates in a medium-scale New Keynesian model with capital. I solve a quantitatively realistic model of the U.S. economy with a ZLB constraint and use Sequential Monte Carlo methods to uncover the shocks that pushed the U.S. economy to the ZLB during the Great Recession. I investigate the interaction between shocks and frictions in generating the contraction of output, consumption and investment during 2008:Q3- 2013:Q4 and find that a combination of shocks to the marginal efficiency of investment and to households’ discount factor generated the prolonged liquidity trap observed in this period. A comparison between these two sources suggests that investment shocks played a more important role during this period. Fiscal and monetary policy stimulus help explain why the U.S. did not fall into a deflationary spiral despite a binding zero bound.

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