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Optimal Price and Inventory Adjustment in an Open-Economy Model of the Business Cycle

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  • Robert P. Flood
  • Robert J. Hodrick

Abstract

This paper presents a macroeconomic model containing optimizing, inventory-holding firms that is consistent with a number of prominent empirical regularities concerning fluctuations in output, exchange rates, relative prices, and money. Prices are sticky, but they are not predetermined. Still, our model is consistent with exchange rate overshooting in the sense of Dornbusch. Typical sticky-price models allow a divergence between current production and current demand, but this divergence is never allowed to feed back into the model. Our optimal inventory adjustments reconcile divergences between current demand and production, and the inventory stock movements provide expected future dynamics.

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  • Robert P. Flood & Robert J. Hodrick, 1985. "Optimal Price and Inventory Adjustment in an Open-Economy Model of the Business Cycle," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 100(Supplemen), pages 887-914.
    • Handle: RePEc:oup:qjecon:v:100:y:1985:i:supplement:p:887-914.
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    Cited by:

    1. Michael Kiley, 2002. "The lead of output over inflation in sticky price models," Economics Bulletin, AccessEcon, vol. 5(5), pages 1-7.
    2. Obstfeld, Maurice & Stockman, Alan C., 1985. "Exchange-rate dynamics," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 18, pages 917-977, Elsevier.
    3. McCallum, Bennett T., 1994. "A semi-classical model of price-level adjustment," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 41(1), pages 251-284, December.
    4. Aizenman, Joshua, 1989. "Monopolistic competition, relative prices, and output adjustment in the open economy," Journal of International Money and Finance, Elsevier, vol. 8(1), pages 5-28, March.
    5. Aizenman, Joshua, 1989. "Market power and exchange rate adjustment in the presence of quotas," Journal of International Economics, Elsevier, vol. 27(3-4), pages 265-282, November.
    6. Robert P. Flood & Robert J. Hodrick, 1986. "Money and the Open Economy Business Cycle: A Flexible Price Model," NBER Working Papers 1967, National Bureau of Economic Research, Inc.
    7. Joshua Aizenman, 1985. "Monopolistic Competition and Deviations from PPP," NBER Working Papers 1552, National Bureau of Economic Research, Inc.
    8. repec:ebl:ecbull:v:5:y:2002:i:5:p:1-7 is not listed on IDEAS

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