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The Natural Rate Hypothesis: an idea past its sell-by date

  • Farmer, Roger

    ()

    (Bank of England)

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). In this paper Roger Farmer reviews a body of work, published over the past decade, in which the author argues that the NRH does not hold in the data and provides an alternative paradigm that explains why it does not hold. Professor Farmer replaces the NRH with the assumption that the animal spirits of investors are a fundamental of the economy that can be modelled by a ‘belief function’. He shows how to operationalise that idea by constructing an empirical model that outperforms the New Keynesian Phillips Curve.

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Article provided by Bank of England in its journal Bank of England Quarterly Bulletin.

Volume (Year): 53 (2013)
Issue (Month): 3 ()
Pages: 244-256

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Handle: RePEc:boe:qbullt:0114
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  1. P. Diamond, 1980. "Aggregate Demand Management in Search Equilibrium," Working papers 268, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Long, John B, Jr & Plosser, Charles I, 1983. "Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 39-69, February.
  3. Beyer, Andreas & Farmer, Roger E. A., 2002. "Natural rate doubts," Working Paper Series 0121, European Central Bank.
  4. Mark Gertler & Antonella Trigari, 2006. "Unemployment Fluctuations with Staggered Nash Wage Bargaining," Computing in Economics and Finance 2006 525, Society for Computational Economics.
  5. Lucas, Robert E, Jr, 1978. "Unemployment Policy," American Economic Review, American Economic Association, vol. 68(2), pages 353-57, May.
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  9. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  10. Farmer, Roger E A & Nourry, Carine & Venditti, Alain, 2013. "The Inefficient Markets Hypothesis: Why Financial Markets Do Not Work Well in the Real World," CEPR Discussion Papers 9283, C.E.P.R. Discussion Papers.
  11. Mark Gertler & Luca Sala & Antonella Trigari, 2008. "An Estimated Monetary DSGE Model with Unemployment and Staggered Nominal Wage Bargaining," Working Papers 341, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  12. Andolfatto, David, 1996. "Business Cycles and Labor-Market Search," American Economic Review, American Economic Association, vol. 86(1), pages 112-32, March.
  13. Franco Modigliani, 1977. "The monetarist controversy; or, should we forsake stabilization policies?," Economic Review, Federal Reserve Bank of San Francisco, issue Spr suppl, pages 27-46.
  14. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  15. Mortensen, Dale T, 1970. "Job Search, the Duration of Unemployment, and the Phillips Curve," American Economic Review, American Economic Association, vol. 60(5), pages 847-62, December.
  16. Milton Friedman, 1971. "A Theoretical Framework for Monetary Analysis," NBER Books, National Bureau of Economic Research, Inc, number frie71-1, December.
  17. Robert E. Hall & Paul R. Milgrom, 2005. "The Limited Influence of Unemployment on the Wage Bargain," NBER Working Papers 11245, National Bureau of Economic Research, Inc.
  18. Kerry A. Pearce & Kevin D. Hoover, 1995. "After the Revolution: Paul Samuelson and the Textbook Keynesian Model," History of Political Economy, Duke University Press, vol. 27(5), pages 183-216, Supplemen.
  19. Howitt, Peter & McAfee, R Preston, 1987. "Costly Search and Recruiting," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(1), pages 89-107, February.
  20. Robert E. Hall, 2005. "Employment Fluctuations with Equilibrium Wage Stickiness," American Economic Review, American Economic Association, vol. 95(1), pages 50-65, March.
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