Can Sticky Price Models with Flexibly Priced Durables Explain Sectoral Comovement?
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Strong procyclical fluctuations in the durable production are the most prominent feature of the response to monetary shocks. This paper investigates the role of preferences in matching this feature of the data in a two-sector sticky price model with flexibly priced durables. The reaction of durables depends crucially on whether preferences are separable between labor and nondurable consumption. When preferences are separable, the model exhibits perverse behavior. Flexibly priced durables contract during periods of economic expansion. However, non-separable preferences substantially improve the ability of the model to generate sectoral comovment. This result hinges upon the fact that the non-separable preferences may indicate the complementarity between nondurable consumption and labor supply, which is absent in the separable preferences.
Abstract
Strong procyclical fluctuations in the durable production are the most prominent feature of the response to monetary shocks. This paper investigates the role of preferences in matching this feature of the data in a two-sector sticky price model with flexibly priced durables. The reaction of durables depends crucially on whether preferences are separable between labor and nondurable consumption. When preferences are separable, the model exhibits perverse behavior. Flexibly priced durables contract during periods of economic expansion. However, non-separable preferences substantially improve the ability of the model to generate sectoral comovment. This result hinges upon the fact that the non-separable preferences may indicate the complementarity between nondurable consumption and labor supply, which is absent in the separable preferences.
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