Working Papers

2006-20 | June 2006

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The Relative Price and Relative Productivity Channels for Aggregate Fluctuations

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This paper demonstrates that sectoral heterogeneity itself--without any additional bells or whistles--has first-order implications for the transmission of aggregate shocks to aggregate variables in an otherwise standard DSGE model. The effects of sectoral heterogeneity on this transmission are decomposed into two channels: a "relative price" channel and a "relative productivity" channel. The relative price channel results from changes in the relative prices of aggregates, such as investment vis-a-vis consumption goods, which occurs in a sectoral model in response to even standard aggregate shocks. The relative productivity channel arises from changes in the distribution of inputs across sectors. We show that, for standard sectoral models, this latter channel is second-order, but becomes first-order if we consider a nontraded input such as capital utilization or introduce a wedge that thwarts the steady-state equalization of marginal products of a traded input across sectors. For reasonable parameterizations, the relative productivity channel causes aggregate productivity to vary procyclically in response to non-technological shocks such as changes in government purchases.

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