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

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 suggestedto improve its fit to the data. We use a Bayesian approach to estimate and compare the baseline sticky price model of Calvo’s [1983. Staggeredpri ces in a utility maximizing framework. Journal of Monetary Economics 12, 383–398.] andt hree 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 staggeredpr ice andw age contracts. Finally, the estimatedin flation parameters of the Taylor rule are stable across models. r 2005 Elsevier B.V. All rights reserved.