Sticky Price Models, Durable Goods, and Real Wage Rigidities

• Published date: 01 March 2019
• Author: M. ALPER ÇENESIZ,LUÍS GUIMARÃES
• Date: 01 March 2019
• DOI: http://doi.org/10.1111/jmcb.12499

DOI: 10.1111/jmcb.12499

M. ALPER C¸ ENESIZ

LU´

IS GUIMAR ˜

AES

Sticky Price Models, Durable Goods, and Real

Wage Rigidities

The standard two-sector New Keynesian model with durable goods is at

odds with conventional wisdom and vector autoregression(VAR) evidence:

Following a monetary shock, the model generates (i) either negative or no

comovement across sectoral outputs and (ii) aggregate neutrality of money

when durable goods’ prices are flexible. Wereconcile theory with evidence

by incorporating real wage rigidities into the standard model: As long as

durable goods’ prices are more flexible than nondurable goods’ prices, we

obtain positive sectoral comovement and, thus, aggregate nonneutrality of

money.

JEL codes: E32, E51, E52

Keywords: durable goods, real wage rigidities, comovement, money.

USING THE STANDARD TWO-SECTOR New Keynesian model,

Barsky, House, and Kimball (BHK) (2007) eloquently demonstrate that the degree

of price flexibility in the durable goods sector dictates the response of aggregate

output to a monetary shock. When nondurable goods’ prices are sticky but durable

goods’ prices are flexible, the outputs of the two sectors move in opposite directions,

leaving aggregate output unchanged. Aggregate output, however, reacts significantly

when nondurable and durable goods’ prices are sticky. But then nondurables out-

put remains virtually unchanged. In other words, the standard New Keynesian model

Wewould like to thank Diogo Lourenc¸o, Manuel Martins, Christian Pierdzioch, Ricardo Reis, and Andr´

e

Silva, seminar participants at cef.up, FEP,and the Reserve Bank of New Zealand, and conference partici-

pants at the University of Beira Interior for helpful comments. Wealso thank two anonymous referees and

the editor Pok-sang Lam for their valuable comments and suggestions. Financial support by the Fundac¸˜

ao

para a Ciˆ

enciaeaTecnologiaisgratefully acknowledged (Projects: IF/01569/2012/CP0155/CT0001,

SFRH/BD/71677/2010, and POCI-01-0145-FEDER-006890).

M. ALPER C¸ ENESIZ is a Research Associate at the cef.up,Faculdade de Economia, Universidade do Porto

(E-mail: alper.cenesiz@gmail.com). LU´

IS GUIMAR˜

AES is a Research Associate at the cef.up, Faculdadede

Economia, Universidade do Porto (E-mail: lguimaraeswn@gmail.com).

Received October 24, 2013; and accepted in revised form January 16, 2018.

Journal of Money, Credit and Banking, Vol. 51, Nos. 2–3 (March–April 2019)

C

2018 The Ohio State University

722 :MONEY,CREDIT AND BANKING

generates either negative sectoral comovementand aggregate neutrality or no sectoral

comovement.

Yet vector autoregression (VAR) evidence overwhelmingly suggests positive co-

movement in the aftermath of a monetary shock. Two stylized facts we read from

several VAR studies are that (i) aggregate output and sectoral outputs move together

and that (ii) the price and output of the durable sector react more strongly than those

of the nondurable sector.1Moreover, the distinctive feature of a business cycle is

that the outputs of many sectors of the economy move together. Therefore, the New

Keynesian model, the workhorse in analysis of monetary business cycles, needs to

be reconciled with these facts. We do so by simply introducing real wage rigidities

into an otherwise standard two-sector New Keynesian model.

One supporting argument for the existence of real wage rigidities flows from the

Dunlop–Tarshis observation—that hours worked and real wages are uncorrelated

(Dunlop 1938 and Tarshis 1939). Regarding the dynamic effects of monetary shocks

on the real wage, we report VAR evidence that the reaction of the real wage is rather

muted, confirming the findings of Altig et al. (2011), Amato and Laubach (2003), and

Christiano, Eichenbaum, and Evans (2005).2As a modeling feature, the crucial role of

real wage rigidities in propagating shocks has also long been recognized. In his review

of business cycle theory, Lucas (1981) argues that models relying on systematic real

wage movements are doomed to failure. Ball and Romer (1990) show that real wage

rigidities amplify the effects of nominal rigidities. Hall (2005) shows that real wage

rigidities generate volatile unemployment and vacancies in the context of search and

matching models. Blanchard and Gali (2007) show that real wage rigidities generate

a trade-off between output and inflation stabilization. More recently, Shimer (2012)

shows that real wage rigidities can account for jobless recoveries.

To model real wage rigidities, we follow Blanchard and Gali (2007): We modify

the labor supply equation of the standard New Keynesian model by assuming that

the real wage is a weighted sum of the lagged real wage and the marginal rate of sub-

stitution between consumption and leisure. Without any other change to the standard

model, this simple modification removes the abovementioned puzzling theoretical re-

sults, that is, it obtains nonneutral money and positive comovement between sectoral

outputs. Using our modification, we first show that when durable goods’ prices are

perfectly flexible, (i) durables output reacts sharply to monetary shocks, (ii) aggregate

1. See, for example, Erceg and Levin (2006), and Monacelli (2009). BHK (2003), using Romer dates,

confirm the same evidence. In Section 1, we report VAR evidence of sectoral comovement.

2. In their thorough survey of wage rigidities and cyclical wage adjustment, Basu and House (2016)

distinguish among different measures of the real wage using longitudinal microdata. In particular, they

analyze the average real wage, the average real wage adjusted by labor force composition (as in Elsby,

Shin, and Solon 2016 and Solon, Barsky, and Parker 1994), the real wage of new hires (as in Haefke,

Sonntag, and van Rens 2013), and the user cost of labor (as in Kudlyak 2014). Basu and House document

that, unlike the average real wage, the other three measures are cyclical and respond significantly to

monetary shocks. Nevertheless, the standard two-sector new Keynesian model, analyzed in BHK (2007)

and that we augment in this paper, assumes a simple spot labor market with homogeneous workersand full

employment. The model abstracts from nontrivial hiring decisions, implicit labor contracts, and changes

in the labor force composition. Thus, the average real wage is the empirical counterpart of the real wage

in the model.