Dynamics of the relative price of nontradable goods and heterogeneity in price stickiness

Dynamics of the relative price of nontradable goods and heterogeneity in price stickiness

This paper investigates the dynamic properties of the relative price of nontradable to tradable goods at business cycle frequencies and …nds that the relative price displays an S -shaped cross correlation structure with GDP. In other words, the relative price tends to be negatively correlated with past GDP and positively correlated with future GDP. In addition, the relative price is highly persistent but its volatility is quite low. Since the S -shaped cross correlation structure is hard to reconcile with existing international macroeconomic models, this paper introduces heterogeneity in price stickiness to explain the regularity and shows that a model with heterogeneous price stickiness in tradable and nontradable sectors can successfully replicate it. However, introducing heterogeneity does not improve results in the existing literature with regard to real exchange rate puzzles.