The New Keynesian Monetary Model. Does it Show the Comovement between Output and Inflation in the U.S. and the Euro Area?

This paper analyzes the performance of alternative versions of the New Keynesian Monetary (NKM) model in order to replicate the comovement observed between output and inflation in the U.S.and the Eurozone. Following Den Haan (2000), we analyze that comovement by computing the correlations of VAR forecast errors of the two variables at different forecast horizons. The empirical correlationsobtained show a weak comovement in the U.S. and the Eurozone. A simple NKM model under a standard parametrization provides a high negative comovementat any forecast horizon whenever the inertial parameter of Taylor rule is smaller than 0.90. However, a basic NKM model with an inertial parameter close to one or, alternatively, a generalized version including habit formation and a forward-looking Taylor rule is able to mimic the observed weak comovement. The good performance of these versions also extends to the case in which the policymaker is committed to following an optimal contingent plan under certain parametrizations.