Do Flexible Durable Goods Prices Undermine Sticky Price Models?

1. Do Flexible Durable Goods Prices Undermine Sticky Price Models? Bob Barsky, Chris House, Miles Kimball. University of Michigan

2. Common Features of Sticky Price Models • One sector. • Symmetric price rigidity. • Often only non-durable goods.

3. Reality • Not all prices are equally sticky. • Example: Coke vs. Lettuce

4. What happens to sticky price models when some prices are flexible? Guess : The model behaves as if all firms had the average degree of price rigidity. • Safe to ignore differences at the aggregate level • Model the economy as though all goods had the average degree of nominal rigidity. This is wrong in general.

5. Findings: • Durable goods are much more important in sticky price models than nondurables. • Durables with flexible prices  strong tendency for negative comovement. • Extreme case: flexibly priced durables imply that money is neutral w.r.t. output and employment.

6. Durable Goods in the Data:

9. Durable Goods in the Data: Durables respond strongly to monetary policy. The relative price of durables falls after a monetary contraction.

10. xjt are net purchases of good j Nondurables: cjt = xjt Durables: dj,t = dj,t-1(1 -d) + xjt Framework Representative agent seeks to maximize: subject to:

11. Prices are markups over marginal cost: Other Features • Labor is mobile across sectors • Money Demand: • Production: Flexible price sectors mjt = mj.

12. gjt: marginal utility of having an additional unit of good j Labor supply decision:

13. For durable goods sectors gjt ≈ gj Why? • Stock / flow distinction • u′(djt)  djt is almost constant. 2. Durables are long-lived

14. The Comovement Problem Consider a durable good with flexible prices

15. The Comovement Problem Consider a durable good with flexible prices If Nt rises then njt must fall.

16. The comovement problem is very robust for durable goods. Demand does not rise for durables (the g’s are all constant)  No income effects for durable goods. MC increase as employment rises (labor mobility).

17. Sticky Prices and the Neutrality of Money • If … • Durables have flexible prices. • Labor is fully mobile • The MPN is roughly constant in the durables sector. Then, money is neutral w.r.t. employment (and output).

18. The same steps above imply: All durables must have flexible prices for neutrality.

19. Labor supply: Neutrality in a model with capital:

20. Neutrality in a model with capital:

21. Simulations: Calvo price setting Price Rigidity: 1.3 changes per year (6 month ½ life of exogenous price rigidity).   Linear production  Utility:

22. Simulations: Calvo price setting Price Rigidity: 1.3 changes per year (6 month ½ life of exogenous price rigidity).   Linear production  Labor supply elasticity: h= 1 Intertemporal substitution : s= 1 Intratemporal substitution: r = 1 Symmetric 10% markup: m= 1.1

29. Do durables have sticky prices? • Many durables are expensive on a per unit basis. •  Negotiation costs are relatively small. • Some durables require customization. • Many new homes are priced for the first time once they are produced.

31. Sticky Wages / Input Prices

33. Related Work • Ohanian and Stockman [1994] • Ohanian, Stockman and Killian [1995] (and Leahy [1995]) • Bils, Klenow and Oleksiy [2003] • Golosov and Lucas [2003]

34. Conclusions: • New Keynesian models behave “as they should” if and only if durables have sticky prices • Durable goods with flexible prices pose serious problems for sticky price models.