Aggregation and Stabilization Policy in a Multi-Contract Economy

This paper presents a model of a multi-sector economy in which each sector is characterized by a different type of wage or price stickiness. The various sectors experience the same exogenous shocks and have the same money supply. The analysis shows demand shocks pose no serious problems for stabilization policy. In contrast, supply shocks force the policymaker to choose between stability in one sector and stability in another. The analysis also shows the economy cannot be usefully aggregated into a single sector model. Such an aggregation misleads the economist as to the economy's underlying structure and obscures the tradeoffs the policymaker must confront. In particular, a feedback rule chosen on the basis of an aggregate model could be better or worse than a passive policy.