1 Introduction
"There is a great deal of heterogeneity in wage and price setting.
In fact, the data suggest that there is as much a difference between
the average lengths of different types of price setting arrangements, or
between the average lengths of different types of wage setting arrange-
ments, as there is between wage setting and price setting. Grocery
prices change much more frequently than magazine prices - frozen or-
ange juice prices change every two weeks, while magazine prices change
every three years! Wages in some industries change once per year on
average, while others change per quarter and others once every two
years. One might hope that a model with homogenous representative
price or wage setting would be a good approximation to this more
complex world, but most likely some degree of heterogeneity will be
required to describe reality accurately."
Taylor (1999).
There are two main approaches to modelling nominal wage and price
rigidity in the dynamic general equilibrium (DGE) macromodels: the stag-
gered contract setting of Taylor ( Taylor (1980)) and the Calvo model of
random contract lengths generated by a constant hazard (reset) probability
(Calvo (1983)). This paper proposes a generalization of the standard Taylor
model to allow for an economy with many different contract lengths: we call
this a Generalized Taylor Economy - GTE for short. The standard approach
in the literature has been to adopt a simple Taylor economy, in which there
is a single contract length in the economy: for example 2 or 4 quarters1. As
the above quote from John Taylor indicates, in practice there is a wide range
of wage and price setting behavior resulting in a variety of contract lengths.
We can use the GTE framework to evaluate whether the hope expressed by
John Taylor that a representative sector approach "is a good approximation
to this more complex world".
An additional advantage of the GTE framework is that it includes the
Calvo model as a special case, in the sense that we can set up the GTE to
1This is not to ignore some recent papers that have allowed for two sectors with different
contract durations, such as Aoki (2001), Erceg and Levin (2002), Carlstrom, Fuerst and
Ghironi (2003) or with multi-sectors such as Mankiw and Reis (2003). However, these
studies are mainly concerned with computing optimal monetary policy in a Dynamic
Equlibrium Setting.