Heterogeneous households in a sticky price DSGE model

This dissertation introduces heterogeneous households into an otherwise standard Dynamic Stochastic General Equilibrium (DSGE) model with Calvo-style sticky goods prices. Labor skills are industry specific. The households are heterogeneous because each household possesses a labor skill specialized exclusively for certain industry and asset markets are incomplete. A household's consumption then depends positively on its labor income and the industry output.; The first chapter shows that the model with heterogeneous households has a greater degree of real rigidity and complementarity in price-setting relative to the standard representative household model, and provides a new explanation for inflation inertia and large and persistent real effects of monetary policy even when firms update their prices frequently. A positive dependence of consumption on labor income leads to a smaller wage elasticity of industry labor supply due to wealth effect. Firms then adjust their prices by a smaller amount than when the asset markets were complete because marginal costs become more sensitive to their pricing decision. I estimate the durations of price contracts implied by the sticky price DSGE models. The model with the heterogeneous households is consistent with empirical evidence in terms of not only mean but also sectoral durations of price contracts. I also show that recognizing the different degrees of price stickiness across sectors is also crucial when one estimates the model-implied durations and makes inferences.; The second chapter discusses implications for optimal monetary policy. I show a central bank should concern more about inflation stabilization if asset markets are imperfect because instable aggregate price level leads to undesired consumption dispersions. However I also show that a central back does not necessarily stabilize inflation more relative to the case of complete asset markets because the cost of stabilizing inflation becomes larger due to a higher degree real rigidity as shown in the first chapter.