DP8100 | Animal Spirits, Persistent Unemployment and the Belief Function

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08/11/2010

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Abstract

This paper presents a theory of the monetary transmission mechanism in a monetary version of Farmer?s (2009) model in which there are multiple equilibrium unemployment rates. The model has two equations in common with the new-Keynesian model; the optimizing IS curve and the policy rule. It differs from the new-Keynesian model by replacing the Phillips curve with a belief function to determine expectations of nominal income growth. I estimate both models using U.S. data and I show that the Farmer monetary model fits the data better than its new-Keynesian competitor.