Working Paper: NBER ID: w22136
Authors: Roger E.A. Farmer; Konstantin Platonov
Abstract: We propose a fresh way of thinking about the monetary transmission mechanism. By integrating Keynesian economics with general equilibrium theory in a new way, we provide an alternative model and an alternative narrative to New-Keynesian economics to explain how macroeconomic policy influences prices and employment. 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 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, without the assumption that prices are prevented from moving by artificial barriers to price adjustment.
Keywords: monetary transmission mechanism; animal spirits; Keynesian economics; general equilibrium theory
JEL Codes: E12; E3; E4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy (E52) | Employment (J68) |
| Monetary policy (E52) | Prices (D49) |
| NAC curve (Y10) | Economic activity (E29) |
| Animal spirits (E32) | Economic activity (E29) |
| Monetary policy (E52) | Real economic activity (E39) |
| Search frictions (J69) | Unemployment (J64) |
| Belief function (D83) | Unemployment rate (J64) |
| Belief function (D83) | Equilibrium selection (C62) |
| Dynamic indeterminacy (D89) | Fluctuations in employment (J63) |
| Dynamic indeterminacy (D89) | Fluctuations in output (E32) |
| Changes in money supply (E51) | Employment (J68) |
| Changes in money supply (E51) | Output (Y10) |