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Animal spirits in a monetary model

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  • Farmer, Roger E.A.
  • Platonov, Konstantin

Abstract

We integrate Keynesian economics with general equilibrium theory in a new way. We develop a simple graphical apparatus, the IS-LM-NAC framework, that can be used by policy makers to understand how policy affects the economy. A new element, the No-Arbitrage-Condition (NAC) curve, connects the interest rate to current and expected future values of the stock market and it explains how ‘animal spirits’ influence economic activity. Our framework provides a rich new approach to policy analysis that explains the short-run and long-run effects of policy.

Suggested Citation

  • Farmer, Roger E.A. & Platonov, Konstantin, 2019. "Animal spirits in a monetary model," European Economic Review, Elsevier, vol. 115(C), pages 60-77.
    • Handle: RePEc:eee:eecrev:v:115:y:2019:i:c:p:60-77
    DOI: 10.1016/j.euroecorev.2019.02.005
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    1. Farmer, Roger E.A. & Nicolò, Giovanni, 2018. "Keynesian economics without the Phillips curve," Journal of Economic Dynamics and Control, Elsevier, vol. 89(C), pages 137-150.
    2. Farmer, Roger E.A. & Nourry, Carine & Venditti, Alain, 2011. "Debt, deficits and finite horizons: The stochastic case," Economics Letters, Elsevier, vol. 111(1), pages 47-49, April.
    3. Jess Benhabib & Roger E.A. Farmer, 2000. "The Monetary Transmission Mechanism," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 3(3), pages 523-550, July.
    4. N. Gregory Mankiw, 1985. "Small Menu Costs and Large Business Cycles: A Macroeconomic Model of Monopoly," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 100(2), pages 529-538.
    5. Farmer, Roger E.A., 2016. "The Evolution Of Endogenous Business Cycles," Macroeconomic Dynamics, Cambridge University Press, vol. 20(2), pages 544-557, March.
    6. Roger E. A. Farmer, 2018. "Pricing Assets in a Perpetual Youth Model," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 30, pages 106-124, October.
    7. Roger Farmer, 2012. "The Stock Market Crash of 2008 Caused the Great Recession," 2012 Meeting Papers 145, Society for Economic Dynamics.
    8. Bilbiie, Florin O., 2008. "Limited asset markets participation, monetary policy and (inverted) aggregate demand logic," Journal of Economic Theory, Elsevier, vol. 140(1), pages 162-196, May.
    9. Roger E. A. Farmer, 2012. "Confidence, Crashes and Animal Spirits," Economic Journal, Royal Economic Society, vol. 122(559), pages 155-172, March.
    10. N. Gregory Mankiw & Ricardo Reis, 2007. "Sticky Information in General Equilibrium," Journal of the European Economic Association, MIT Press, vol. 5(2-3), pages 603-613, 04-05.
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    12. Beyer, Andreas & Farmer, Roger E.A., 2007. "Natural rate doubts," Journal of Economic Dynamics and Control, Elsevier, vol. 31(3), pages 797-825, March.
    13. Diamond, Peter A, 1982. "Aggregate Demand Management in Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 881-894, October.
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    15. Kenneth J. Matheny, 1998. "Non-neutral responses to money supply shocks when consumption and leisure are Pareto substitutes," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 11(2), pages 379-402.
    16. Farmer, Roger E A, 1991. "Sticky Prices," Economic Journal, Royal Economic Society, vol. 101(409), pages 1369-1379, November.
    17. Farmer, Roger E.A., 2012. "The stock market crash of 2008 caused the Great Recession: Theory and evidence," Journal of Economic Dynamics and Control, Elsevier, vol. 36(5), pages 693-707.
    18. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Hysteresis and the European Unemployment Problem," NBER Chapters, in: NBER Macroeconomics Annual 1986, Volume 1, pages 15-90, National Bureau of Economic Research, Inc.
    19. Roger E. A. Farmer, 2015. "The Stock Market Crash Really Did Cause the Great Recession," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 77(5), pages 617-633, October.
    20. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    21. Roger E.A. Farmer, 2013. "Animal Spirits, Financial Crises and Persistent Unemployment-super-," Economic Journal, Royal Economic Society, vol. 0, pages 317-340, May.
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    24. Farmer, Roger E. A., 2014. "How the Economy Works: Confidence, Crashes and Self-Fulfilling Prophecies," OUP Catalogue, Oxford University Press, number 9780199360307.
    25. Frank Smets & Rafael Wouters, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," American Economic Review, American Economic Association, vol. 97(3), pages 586-606, June.
    26. Roger E. A. Farmer, 2002. "Why Does Data Reject the Lucas Critique," Annals of Economics and Statistics, GENES, issue 67-68, pages 111-129.
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    29. Farmer, Roger, 2010. "Expectations, Employment and Prices," OUP Catalogue, Oxford University Press, number 9780195397901.
    30. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-247, April.
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    32. Carlin, Wendy & Soskice, David, 2014. "Macroeconomics: Institutions, Instability, and the Financial System," OUP Catalogue, Oxford University Press, number 9780199655793.
    33. Farmer, Roger E.A. & Woodford, Michael, 1997. "Self-Fulfilling Prophecies And The Business Cycle," Macroeconomic Dynamics, Cambridge University Press, vol. 1(4), pages 740-769, December.
    34. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
    35. Dmitry Plotnikov, 2019. "Hysteresis in unemployment: A confidence channel," International Journal of Economic Theory, The International Society for Economic Theory, vol. 15(1), pages 109-127, March.
    36. Farmer, Roger E.A., 2016. "Prosperity for All: How to Prevent Financial Crises," OUP Catalogue, Oxford University Press, number 9780190621438.
    37. Stanley Fischer, 1986. "NBER Macroeconomics Annual 1986, Volume 1," NBER Books, National Bureau of Economic Research, Inc, number fisc86-1.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Farmer, Roger E.A. & Nicolò, Giovanni, 2018. "Keynesian economics without the Phillips curve," Journal of Economic Dynamics and Control, Elsevier, vol. 89(C), pages 137-150.
    2. Upravitelev, A., 2023. "Neoclassical roots of behavioral economics," Journal of the New Economic Association, New Economic Association, vol. 58(1), pages 110-140.
    3. Gabriel Desgranges & Sayantan Ghosal, 2021. "Partial Consensus in Large Games and Markets," Working Papers 2021_02, Business School - Economics, University of Glasgow.
    4. Petach, Luke & Tavani, Daniele, 2022. "Aggregate demand externalities, income distribution, and wealth inequality," Structural Change and Economic Dynamics, Elsevier, vol. 60(C), pages 433-446.
    5. Gardini, Laura & Radi, Davide & Schmitt, Noemi & Sushko, Iryna & Westerhoff, Frank, 2023. "Sentiment-driven business cycle dynamics: An elementary macroeconomic model with animal spirits," Journal of Economic Behavior & Organization, Elsevier, vol. 210(C), pages 342-359.
    6. Farmer, Roger, 2019. "The Indeterminacy School in Macroeconomics," CEPR Discussion Papers 13745, C.E.P.R. Discussion Papers.
    7. Giovanni Nicolo, 2020. "Monetary Policy, Self-Fulfilling Expectations and the U.S. Business Cycle," Finance and Economics Discussion Series 2020-035, Board of Governors of the Federal Reserve System (U.S.).
    8. D. Masciandaro, 2019. "What Bird Is That? Central Banking And Monetary Policy In The Last Forty Years," BAFFI CAREFIN Working Papers 19127, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    9. Roger E.A. Farmer & Giovanni Nicolò, 2021. "Some International Evidence for Keynesian Economics Without the Phillips Curve," Manchester School, University of Manchester, vol. 89(S1), pages 1-22, September.
    10. Roger E. A. Farmer, 2018. "Pricing Assets in a Perpetual Youth Model," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 30, pages 106-124, October.
    11. Oscar Jorda & Alan Taylor & Sanjay Singh, 2019. "The Long-Run Effects of Monetary Policy," 2019 Meeting Papers 1307, Society for Economic Dynamics.
    12. He, Yiyao, 2022. "Heterogeneous stock traders, endogenous bubbles, and economic fluctuations," Finance Research Letters, Elsevier, vol. 47(PA).
    13. Ignacio Escañuela ROMANA, 2016. "Randomness, Determinism and Undecidability in the Economic Cycle Theory," Journal of Economics and Political Economy, KSP Journals, vol. 3(4), pages 638-658, December.
    14. Luke Petach & Daniele Tavani, 2021. "Aggregate Demand Externalities, Income Distribution, and Wealth Inequality," FMM Working Paper 66-2021, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
    15. Stijn Claessens & M Ayhan Kose, 2018. "Frontiers of macrofinancial linkages," BIS Papers, Bank for International Settlements, number 95.
    16. Roger E A Farmer, 2020. "The importance of beliefs in shaping macroeconomic outcomes," Oxford Review of Economic Policy, Oxford University Press and Oxford Review of Economic Policy Limited, vol. 36(3), pages 675-711.
    17. Escañuela Romana, Ignacio, 2016. "Azar, Determinismo e Indecidibilidad en la Teoría del Ciclo Económico [Randomness, Determinism and Undecidability in the Business Cycle Theory]," MPRA Paper 72978, University Library of Munich, Germany.
    18. Marques, André M. & Carvalho, André R., 2022. "Testing the neo-fisherian hypothesis in Brazil," The Quarterly Review of Economics and Finance, Elsevier, vol. 86(C), pages 407-419.
    19. Roger E A Farmer, 2019. "The Indeterminacy Agenda in Macroeconomics," National Institute of Economic and Social Research (NIESR) Discussion Papers 507, National Institute of Economic and Social Research.

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    More about this item

    Keywords

    Animal spirits; Sunspots; Keynesian economics;
    All these keywords.

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates

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