Liquidity Preference and Persistent Unemployment with Dynamic Optimizing Agents

Standard money-in-utlity dynamic models assume satiable liquidity preference, and thereby prove the existence of a full employment steady state. Using the same model, Ono (1994) shows that under insatiable liquidity preference there is a case where a full employment steady state does not exist and then unemployment persistently occurs. Using both parametric and nonparametric methods this paper empirically finds that insatiable liquidity preference is strongly supported. Thus, without assuming any permanent distortion as Old and New Keynesians do, we can analyze an effective demand shortage in a dynamic optimization framework.