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Rethinking ExpectationsThe Way Forward for Macroeconomics$
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Roman Frydman and Edmund S. Phelps

Print publication date: 2013

Print ISBN-13: 9780691155234

Published to Princeton Scholarship Online: October 2017

DOI: 10.23943/princeton/9780691155234.001.0001

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Animal Spirits, Persistent Unemployment, and the Belief Function

Animal Spirits, Persistent Unemployment, and the Belief Function

(p.251) Chapter Seven Animal Spirits, Persistent Unemployment, and the Belief Function
Rethinking Expectations

Roger E. A. Farmer

Princeton University Press

This chapter examines the persistence of unemployment by drawing from John Maynard Keynes' two central ideas. The first idea is that any unemployment rate can persist as an equilibrium. The second is that the unemployment rate that prevails is determined by animal spirits. The chapter introduces a three-equation monetary model termed “Farmer monetary model,” which replaces the New Keynesian Phillips curve with a belief function that describes how agents form expectations of future nominal income. The chapter builds and estimates the Farmer monetary model using U.S. data for the period from the first quarter of 1952 to the fourth quarter of 2007. It compares the Farmer monetary model to a New Keynesian model by computing the posterior odds ratio. It shows that the posterior odds favor the Farmer monetary model and concludes by discussing the implications of this finding for fiscal and monetary policy.

Keywords:   unemployment rate, John Maynard Keynes, animal spirits, Farmer monetary model, New Keynesian Phillips curve, belief function, expectations, fiscal policy, monetary policy

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