DP8401 Unemployment in an Estimated New Keynesian Model

Author(s): Jordi Galí, Frank Smets, Rafael Wouters
Publication Date: May 2011
Keyword(s): Nominal rigidities, output gap, Phillips curve, unemployment fluctuations, wage markup shocks
JEL(s): D58, E24, E31, E32
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8401

We reformulate the Smets-Wouters (2007) framework by embedding the theory of unemployment proposed in Galí (2011a,b). We estimate the resulting model using postwar U.S. data, while treating the unemployment rate as an additional observable variable. Our approach overcomes the lack of identification of wage markup and labor supply shocks highlighted by Chari, Kehoe and McGrattan (2008) in their criticism of New Keynesian models, and allows us to estimate a "correct" measure of the output gap. In addition, the estimated model can be used to analyze the sources of unemployment fluctuations.