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Intertemporal Substitution and Sectoral Comovement in a Sticky Price Model

Strong procyclical fluctuations in the durable production are the most prominent feature of the empirical 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 aggregate consumption. When preferences are separable, the model exhibits perverse behavior. Flexibly priced durables contract during periods of economic expansion. However, sticky price model with non-separable preferences can replicate the empirically plausible response of durable spending. The key to the model’s success hinges upon the fact that the non-separable preferences imply the complementarity between aggregate consumption and labor supply, absent in the separable preference. Finally, we present empirical evidence supporting the non-separable preferences.

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Paper provided by Department of Economics, Louisiana State University in its series Departmental Working Papers with number 2010-01.

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Handle: RePEc:lsu:lsuwpp:2010-01
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  1. Barro, Robert J & Sahasakul, Chaipat, 1986. "Average Marginal Tax Rates from Social Security and the Individual Income Tax," The Journal of Business, University of Chicago Press, vol. 59(4), pages 555-66, October.
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  12. Charles T. Carlstrom & Timothy S. Fuerst, 2006. "Co-movement in sticky price models with durable goods," Working Paper 0614, Federal Reserve Bank of Cleveland.
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  19. repec:ucp:bknber:9780226304557 is not listed on IDEAS
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