Essays on Durable Goods and Housing in New Keynesian Models

While they are widely used for policy, two sector New Keynesian models with flexibly priced durable goods are rejected by the data. After a monetary policy shock,these models typically demonstrate negative co-movement between durable and nondurable consumption. This is completely at odds with VAR evidence which suggests that they co-move positively (and that durable good consumption is substantially more sensitive than non-durable good consumption to the shock). This thesis focuses on and explores a number of possible solutions to this puzzle and ultimately proposes a model that resolves the puzzle and retains many of the appealing attributes of modern macroeconomic models for policy analysis. After an introduction that describes the durable good co-movement puzzle in greater detail, chapter 2 examines the potential of a simple production linkage - where nondurable goods are used for consumption but also as inputs into the production of durable goods - to resolve it. This approach is simple and intuitive. But, while it generates positive co-movement, it struggles to capture the responsiveness of durable goods to the shock. Chapter 3 examines whether restrictive assumptions on the demand side might be hindering the model’s capacity to be accepted by the data. Specifically, it uses the Kimball (1995) aggregator to introduce smoothed kinked demand curves for both types of goods. This yields an augmented New Keynesian Phillips’ curve that dampens the response of prices to changes in marginal cost and, as a result, a model capable of generating positive co-movement at levels of nominal price rigidity far lower than in standard New Keynesian models. Chapter 4 examines how the introduction of a borrowing constraint into the standard two sector New Keynesian model affects the generation of positive co-movement. While earlier works have shown that this extension actually makes it more difficult to generate positive co-movement, they have been far less conclusive in diagnosing why. According to one theory, when the constraint tightens after an unanticipated increase in the policy rate, savers find that they are prevented from saving as much as they would like and, as a result, are forced to transfer consumption into the future through the purchase of durable goods (thus exacerbating the negative co-movement). The model in this chapter considers this contention and demonstrates that, even when they are given other ways to save, savers prefer to purchase durable goods. The desire to purchase of durable goods is so strong that they even borrow in these alternative markets in order to do so. Chapter 5 uses the introduction of nominal wage frictions to reconcile the model with the borrowing constraint with the empirical literature. It also extends the model to include a fully specified financial sector and macroprudential policy. (It also examines some of the policy trade-offs inherent in macroprudential policy and monetary policy that targets financial aggregates.) In this sense, the model in this chapter offers a coherent and consistent workhorse model for future policy analysis