The Natural Rate Hypothesis: An Idea Past its Sell-By Date
Roger E. A. Farmer
University of California, Los Angeles (UCLA) - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)
NBER Working Paper No. w19267
Central banks throughout the world predict inflation with new-Keynesian models where, after a shock, the unemployment rate returns to its so called "natural rate'. That assumption is called the Natural Rate Hypothesis (NRH). This paper reviews a body of work, published over the last decade, which is critical of the NRH. I argue that the NRH does not hold in the data and I provide an alternative paradigm that explains why it does not hold. I replace the NRH with the assumption that the animal spirits of investors are a fundamental of the economy and I show how to operationalize that idea by constructing an empirical model that outperforms the new-Keynesian Phillips curve. I model animal spirits with a new fundamental that I call the belief function.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
Number of Pages in PDF File: 15
Date posted: August 1, 2013
© 2015 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo1 in 0.328 seconds