Unemployment, the Business Cycle and Monetary Policy

This work develops and simulates a New Keynesian DSGE model that incorporates a variant of the Diamond Mortensen Pissarides Search and Matching model of the labor market. Fluctuations in involuntary unemployment are an integral part of the business cycle and an unpleasant fact of everyday life. However, conventional New Keynesian models struggle to account for involuntary unemployment. In contrast, the model presented in the book extends the conventional New Keynesian model to a more realistic framework that incorporates involuntary equilibrium unemployment and delivers predictions for labor market flows. As a result, the model is able to capture the reaction of unemployment to a monetary policy shock. The framework also accounts for the observed inertia and persistence in several other important aggregate quantities like GDP, investment and consumption.