A monetary business cycle model with unemployment

To reproduce key features of the post-war U.S. data, most monetary business cycle models must assume there are high price markups and that agents have high labour supply elasticities despite the existence of contradictory microeconomic evidence. This paper eliminates the need for these assumptions by introducing imperfectly observed effort into a limited participation model. The estimated model is better able to capture the sluggish price response to a monetary policy shock than the standard model, and is consistent with evidence regarding the qualitative responses of the U.S. economy to technology shocks, fiscal policy shocks and monetary policy shocks.