The New Keynesian Monetary Model: Does It Show the Comovement between GDP and Inflation in the U.S.?

Jesús Vázquez, Universidad del País Vasco

Abstract

This paper analyzes the performance of alternative versions of the New Keynesian Monetary (NKM) model in replicating the comovement observed between output and inflation. Following Den Haan (2000), we analyze comovement by computing the correlations of VAR forecast errors of the two variables at different forecast horizons. The empirical correlation is negative and marginally significant for the one-ahead forecast horizon, but the correlations are non-significant for the other forecast horizons studied. In contrast, a simple NKM model under a standard parameterization provides a high and significant negative comovement at all forecast horizons. However, a generalized version including habit formation and a forward-looking Taylor rule is able to mimic the observed weak comovement at medium- and long-term forecast horizons.