Small-scale New Keynesian model features that can reproduce lead, lag and persistence patterns

Abstract

This paper uses a new method for describing dynamic comovement and persistence in economic time series which builds on the contemporaneous forecast error method developed in den Haan [den Haan, W. J. 2000. “The Comovement between Output and Prices.” Journal of Monetary Economics 46: 3–30]. This data description method is then used to address issues in New Keynesian model performance in two ways. First, well known data patterns, such as output and inflation leads and lags and inflation persistence, are decomposed into forecast horizon components to give a more complete description of the data patterns. These results show that the well-known lead and lag patterns between output and inflation arise mostly in the medium-term forecasts horizons. Second, the data summary method is used to investigate a small-scale New Keynesian model with some important modeling features to see which of these features can reproduce lead, lag and persistence patterns seen in the data. We show that a general equilibrium model with habit formation, persistent IS curve shocks and persistent supply shocks can reproduce the lead, lag and persistence patterns seen in the data.