Comparing New Keynesian models of the business cycle: A Bayesian approach

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jmoneco.2005.08.008 Byline: Pau Rabanal (a), Juan F. Rubio-Ramirez (b) Abstract: The baseline New Keynesian model cannot replicate the observed persistence in inflation, output, and real wages for sensible parameter values. As a result, several extensions have been suggested to improve its fit to the data. We use a Bayesian approach to estimate and compare the baseline sticky price model of Calvo's [1983. Staggered prices in a utility maximizing framework. Journal of Monetary Economics 12, 383-398.] and three extensions. Our empirical results are as follows. First, we find that adding price indexation improves the fit of Calvo's [1983. Staggered prices in a utility maximizing framework. Journal of Monetary Economics 12, 383-398.] model. Second, models with both staggered price and wage setting dominate models with only price rigidities. Third, introducing wage indexation does not significantly improve the fit. Fourth, all model estimates suggest a high degree of price stickiness. Fifth, the estimates of labor supply elasticity are higher in models with both staggered price and wage contracts. Finally, the estimated inflation parameters of the Taylor ruleare stable across models. Author Affiliation: (a) International Monetary Fund, 700 19th Street NW, Washington, DC 20431, USA (b) Research Department,Federal Reserve Bank of Atlanta, 1000 Peachtree Street, NE, Atlanta, GA 30309, USA Article Note: (footnote) [star] This paper circulated previously under the name 'Nominal versus Real Wage Rigidities: A Bayesian Approach.' We are thankful to Pierpaolo Benigno, Jesus Fernandez-Villaverde, Jordi Gali, Mark Gertler, Andrew Levin, Sydney Ludvigson, Jim Nason, Simon Potter, Ellis Talman, Tao Zha, and seminar participants at various institutions for their useful comments. We are also grateful to an anonymous referee and to the editor, Bob King, for detailed comments. We also thank the financial support from Banco de EspaA[+ or -]a, the Minnesota Supercomputing Institute, and Fundacion BBVA(1/BBVA 00044.321-15466/2002) for financial support. All remaining errors and omissions are our own. The views expressed in this paper are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Atlanta, the Federal Reserve System, or the International Monetary Fund.