Download this Paper Open PDF in Browser

The Natural Rate Hypothesis: An Idea Past its Sell-By Date

15 Pages Posted: 1 Aug 2013  

Roger E. A. Farmer

University of California, Los Angeles (UCLA) - Department of Economics; University of Warwick; National Institute of Economic and Social Research (NIESR); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: August 2013

Abstract

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.

Suggested Citation

Farmer, Roger E. A., The Natural Rate Hypothesis: An Idea Past its Sell-By Date (August 2013). NBER Working Paper No. w19267. Available at SSRN: https://ssrn.com/abstract=2304694

Roger E.A. Farmer (Contact Author)

University of California, Los Angeles (UCLA) - Department of Economics ( email )

Bunche Hall 8283
P.O. Box 951477
Los Angeles, CA 90095-1477
United States
310-825-6547 (Phone)
310-825-9528 (Fax)

University of Warwick ( email )

Coventry CV4 7AL
United Kingdom

HOME PAGE: http://Rogerfarmer.com

National Institute of Economic and Social Research (NIESR) ( email )

2 Dean Trench Street
Smith Square
London, SW1P 3HE
United Kingdom

HOME PAGE: http://NIESR.ac.uk

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Paper statistics

Downloads
55
Rank
255,403
Abstract Views
453