Unemployment in an estimated new Keynesian model

TLDR: This paper reformulated the Smets-Wouters (2007) framework by embedding the theory of unemployment proposed in Gali (2011a,b) and estimate the resulting model using postwar U.S. data, while treating the unemployment rate as an additional observable variable.

Abstract: We reformulate the Smets-Wouters (2007) framework by embedding the theory of unemployment proposed in Gali (2011a,b). We estimate the resulting model using postwar U.S. data, while treating the unemployment rate as an additional observable variable. Our approach overcomes the lack of identification of wage markup and labor supply shocks highlighted by Chari, Kehoe and McGrattan (2008) in their criticism of New Keynesian models, and allows us to estimate a "correct" measure of the output gap. In addition, the estimated model can be used to analyze the sources of unemployment fluctuations.