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Aggregate Implications of Heterogeneous Households in a Sticky-Price Model

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  • I would like to thank Chris Sims, Nobuhiro Kiyotaki, Ricardo Reis, Sam Schulhofer-Wohl, Lars Svensson, Per Krusell, Roberto Chang, Bruce Mizrach, John Landon-Lane, Yongsung Chang, Tack Yun, Jinil Kim, Jonathan Heathcote, Carlos Carvalho, Harold Cole, Dirk Krueger, Jae Sim, and Woong Yong Park. I have benefited from comments by Paul Evans (the editor) and two anonymous referees. A version of this paper was presented at Princeton, Rutgers, Ohio State, Indiana, U-Conn, UC-Davis, Georgetown, FRB-Boston, and the Federal Reserve Board. I thank numerous seminar participants for helpful comments and discussions. I thank the Sidney Simon Grant and the Rutgers Research Council Grant for financial help.

Abstract

This paper analyzes the role of heterogeneous households in propagating shocks over the business cycle by generalizing a basic sticky-price model to allow for imperfect risk sharing between households that differ in labor incomes. I show that imperfectly insured household consumption distorts household incentive to supply labor hours through an idiosyncratic income effect, which in turn generates strategic complementarities in price setting and thus amplifies business cycle fluctuations. This mechanism diminishes the role of nominal rigidities and makes sticky-price models more consistent with microeconomic evidence on the frequency of price changes.

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