Comparing new Keynesian models in the Euro area: a Bayesian approach

Abstract

This paper estimates and compares four versions of the sticky price New Keynesian model for the Euro area using a Bayesian approach. We find that the average duration of price contracts is between two and four quarters, while the average duration of wage contracts is estimated to be below two quarters. Both mechanisms of price and wage indexation are not important when autocorrelated price markup shocks are introduced in the model. These results are in stark contrast to Smets and Wouters (2003): when we use their priors, our estimated posterior distributions are similar to theirs, but the models’ fit to the data is worse.