Credit frictions and co-movement of durable and non-durable goods in a small open economy
Multi-sector sticky price models produce unusual outcomes when the prices of durable goods are flexible. This is because, on the one hand, as empirical evidence suggests, a monetary policy shock results in the positive movement of aggregate consumption in both durable and non-durable goods sectors. On the other, it is because the movement of durable goods is greater than that of non-durable goods, as suggested by Erceg and Levin (2002, 2006). On the other hand, Barsky et al. (2003) show that in a two-sector economy with flexibly priced durable goods and sticky priced non-durable goods, the flexibility of prices of durable goods governs the response of aggregate consumption to a monetary policy tightening. This is because the shadow value of durable goods is approximately constant owing to the typically high stock-to-flow ratio of durable goods. Thus, the responsiveness of the user cost of durable goods does not result in an improvement in total utility for the households.
Sep 2018