Animal Spirits in a Monetary Model

Roger E.A. Farmer, Konstantin Platonov

NBER Working Paper No. 22136
Issued in March 2016
NBER Program(s):   EFG   ME 

We integrate Keynesian economics with general equilibrium theory in a new way. Our approach differs from the prevailing New Keynesian paradigm in two ways. First, our model displays steady state indeterminacy. This feature allows us to explain persistent unemployment which we model as movements among the steady state equilibria of our model. Second, our model displays dynamic indeterminacy. This feature allows us to explain the real effects of nominal shocks by selecting a dynamic equilibrium where prices are slow to respond to unanticipated money supply disturbances. Price rigidity arises as part of a rational expectations equilibrium in which the equilibrium is selected by beliefs. To close our model, we introduce a new fundamental that we refer to as the belief function.