DP14185 The importance of beliefs in shaping macroeconomic outcomes

Author(s): Roger E A Farmer
Publication Date: December 2019
Keyword(s): Fiscal policy, Keynesian economics, unemployment
JEL(s): D50, E12, E24, E32
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14185

For the past thirty years of the history of macroeconomic thought, the Indeterminacy School of Macroeconomics has used general equilibrium models with indeterminate equilibria to understand the independent role of beliefs in shaping macroeconomic outcomes. In this paper I describe the most recent advances in the indeterminacy agenda, Keynesian Search Theory, in which the steady-state unemployment rate is indeterminate as a consequence of labour-market frictions. In Keynesian Search Theory, the belief of market participants is an independent exogenous variable that selects a steady-state equilibrium. I study two assumptions about beliefs, one where investment is exogenous and one where the belief about the stock market is exogenous and I examine their implications for fiscal policy.