Putting the New Keynesian Model to a Test

Abstract

This paper shows how the popular New Keynesian DSGE model can be used to derive sign restrictions for the identification of several shocks in a structural vector autoregression (SVAR) for the Euro Area. The impact is first estimated for respec-tively monetary policy, preferences, government spending, investment, price mark-up, technology and labor supply shocks. In a second step, the restrictions from the DSGE model are significantly relaxed and the SVAR is re-estimated with a minimum set of more general constraints. The data can then provide more information about the validity of the DSGE model. It is shown that most of the responses remain consis-tent with the New Keynesian model, including the controversial negative effects of a government spending shock on private consumption and investment. Some interesting differences, however, emerge. In contrast to the theoretical model, a positive effect of a technology shock on employment, and a positive impact of a preferences and investment shock on respectively investment and consumption are found.