Durable Goods and Persistent Recession

In this paper, we develop a two-sector DSGE model with infrequent purchases of durable goods and use it to address the following three issues. Does this model help explain the recent weak recovery? Can this model help resolve the absence of co-movement between durable and non-durable consumption? Is the dynamic behavior of this model similar with that of the (durable goods) stock adjustment-cost model? First, we allow for the possibility of (temporary) future durable-goods price shocks with ambiguous signals in expectations of households. We then illustrate that when anticipation of these future durable-goods price shocks takes place, the duration of recession can increase. Second, we demonstrate that the presence of idiosyncratic preference shocks to leisure in the absence of complete state-contingent financial market helps explain co-movement between durable and non-durable consumption. The main reason for this result is that, with heterogenous households and financial market incompleteness, we derive the aggregate consumption function by aggregating individual consumption functions that connect each household’s consumption directly to its wealth including housing wealth. Third, we demonstrate that since infrequent purchases of durable-goods generate inter-temporal links of durable-goods holdings, the dynamic responses of our model with respect to interest rate shocks can be similar to those of (durable goods) stockaccumulation models with convex adjustment costs widely used in recent literature. JEL classification: E21; E31; E32