Heterogeneity in Sectoral Price Stickiness, Aggregate Dynamics and Monetary Policy Pitfalls with Real Shocks

Ample differences in sectoral price stickiness is a widely documented fact. This paper shows that in presence of real shocks, heterogeneity in sectoral price stickiness plays a key role in the determination of the aggregate dynamics. The larger price stickiness heterogeneity, the smaller the persistence of inflation and the volatility of inflation, interest rate and output-gap. Thus, two economies with the same average degree of sectoral price stickiness but unlike variance may behave very differently. In terms of monetary policy, they can require interest rate paths that substantially differ both qualitatively and quantitatively. Generally, with real shocks, disregarding the dispersion in sectoral price stickiness leads policymakers to overvalue the variation and persistence of inflation and output gap.