Working Paper: CEPR ID: DP8401
Authors: Jordi Gal; Frank Smets; Rafael Wouters
Abstract: 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.
Keywords: Nominal rigidities; Output gap; Phillips curve; Unemployment fluctuations; Wage markup shocks
JEL Codes: D58; E24; E31; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| unemployment (J64) | identification of wage markup and labor supply shocks (J29) |
| wage markup shocks (J39) | fluctuations in real GDP (E32) |
| unemployment (J64) | prominence of labor supply shocks in explaining fluctuations in output and employment (J20) |
| wage markup shocks (J39) | output fluctuations (E39) |
| wage markup shocks (J39) | output inefficiencies (D61) |
| labor supply shocks (J20) | fluctuations in employment and the labor force (J63) |
| wage markup shocks (J39) | welfare-relevant output gap (D69) |