The New Keynesian Model and Excess Inflation Volatility

This paper represents the latest installment in a highly influential series of papers in which Paul Beaudry and Franck Portier shed light on the empirics and theory of demand shocks. The present paper makes two contributions. One is to show that a standard neoclassical model augmented to allow for labor market segmentation can produce comovement in output, consumption, investment, hours, and the price of capital in response to demand shocks. The second contribution is to argue that labor market segmentation can also improve the prediction of the New Keynesian model for inflation dynamics in response to demand shocks. I find these contributions quite relevant. In this discussion, I argue that the paper must be interpreted as a very first step, and that whether labor market segmentation is a relevant friction that ought to be incorporated in mediumscale macro models remains to be demonstrated. Specifically, I will argue that it is not clear that existing mediumscale models have a particularly hard time either producing comovement in real variables or explaining observed movements in inflation. I will close by suggesting that a natural next step in this research agenda should be to put labor market segmentation to compete econometrically with other real frictions and nominal rigidities to ascertain whether the data favors its presence.