Heterogeneous Households, Real Rigidity, and Estimated Duration of Price Contract in a Sticky-Price DSGE Model

Abstract

This paper develops and estimates a multi-sector sticky-price model with heterogeneous households and incomplete markets. I show that household heterogeneity amplifies the persistence and volatility of business cycle fluctuations by generating strategic complementarities in firms' pricing decision. Moreover this effect of household heterogeneity, when combined with sectoral heterogeneity in price stickiness, is even stronger. As a consequence, the nominal rigidities required to explain the observed characteristics of the U.S. time series, such as persistent and volatile output fluctuations and inertial inflation, is reduced relative to conventional sticky-price models with a representative household, which makes the model more consistent with microeconomic evidences on frequency of price changes.