Intertemporal Substitution and Sectoral Comovement in aSticky Price Model

Strong procyclical fluctuations in the durable production are the most prominent featureof the empirical response to monetary shocks. This paper investigates the role of preferencesin matching this feature of the data in a two-sector sticky price model with flexibly priceddurables. The reaction of durables depends crucially on whether preferences are separable betweenlabor and aggregate consumption. When preferences are separable, the model exhibitsperverse behavior. Flexibly priced durables contract during periods of economic expansion.However, sticky price model with non-separable preferences can replicate the empiricallyplausible response of durable spending. The key to the model’s success hinges upon thefact that the non-separable preferences imply the complementarity between aggregate consumptionand labor supply, absent in the separable preference. Finally, we present empiricalevidence supporting the non-separable preferences....