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Inventories and Optimal Monetary Policy

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  • Thomas A. Lubik

    ()
    (Federal Reserve Bank, Richmond)

  • Wing Leong Teo

    ()
    (Department of Economics, National Taiwan University)

Abstract

We introduce inventories into a standard New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model to study the effect on the design of optimal monetary policy. The possibility of inventory investment changes the transmission mechanism in the model by decoupling production from final consumption. This allows for a higher degree of consumption smoothing since firms can add excess production to their inventory holdings. We consider both Ramsey optimal monetary policy and a monetary policy that maximizes consumer welfare over a set of simple interest rate feedback rules. We find that in contrast to a model without inventories, Ramsey-optimal monetary policy in a model with inventories deviates from complete inflation stabilization. In the standard model, nominal price rigidity is a deadweight loss on the economy, which an optimizing policymaker attempts to remove. With inventories, a planner can reduce consumption volatility and raise welfare by accumulating inventories and letting prices change as an equilibrating mechanism. We find also find that the application of simple rules comes very close to replicating Ramsey optimal outcomes.

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File URL: http://www.economics.adelaide.edu.au/research/papers/doc/wp2009-33.pdf
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Bibliographic Info

Paper provided by University of Adelaide, School of Economics in its series School of Economics Working Papers with number 2009-33.

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Length: 33 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:adl:wpaper:2009-33

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Web page: http://www.economics.adelaide.edu.au/
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Keywords: Ramsey policy; New Keynesian model;

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References

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  1. Peter N. Ireland, 2002. "Technology Shocks in the New Keynesian Model," Boston College Working Papers in Economics, Boston College Department of Economics 536, Boston College Department of Economics.
  2. Aubhik Khan & Julia K. Thomas, 2004. "Inventories and the business cycle: an equilibrium analysis of (S,s) policies," Working Papers 04-11, Federal Reserve Bank of Philadelphia.
  3. Thomas A. Lubik & Wing Leong Teo, 2010. "Inventories, Inflation Dynamics and the New Keynesian Phillips Curve," CAMA Working Papers 2010-13, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  4. Jung, YongSeung & Yun, Tack, 2005. "Monetary Policy Shocks, Inventory Dynamics, and Price-Setting Behavior," Santa Cruz Department of Economics, Working Paper Series qt3sf4q6nn, Department of Economics, UC Santa Cruz.
  5. Mark Bils & James A. Kahn, 1999. "What Inventory Behavior Tells Us About Business Cycles," NBER Working Papers 7310, National Bureau of Economic Research, Inc.
  6. Jonas D.M. Fisher & Andreas Hornstein, 1998. "(S,s) Inventory policies in general equilibrium," Working Paper, Federal Reserve Bank of Richmond 97-07, Federal Reserve Bank of Richmond.
  7. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, Econometric Society, vol. 50(6), pages 1345-70, November.
  8. Ramey, Valerie A. & West, Kenneth D., 1999. "Inventories," Handbook of Macroeconomics, Elsevier, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 13, pages 863-923 Elsevier.
  9. Schmitt-Grohé, Stephanie & Uribe, Martín, 2004. "Optimal Simple and Implementable Monetary and Fiscal Rules," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4334, C.E.P.R. Discussion Papers.
  10. Christiano, Lawrence J., 1988. "Why does inventory investment fluctuate so much?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 21(2-3), pages 247-280.
  11. Andrew T. Levin & Alexei Onatski & John Williams & Noah M. Williams, 2006. "Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models," NBER Chapters, in: NBER Macroeconomics Annual 2005, Volume 20, pages 229-312 National Bureau of Economic Research, Inc.
  12. Martin Boileau & Marc-Andre Letendre, 2011. "Inventories, sticky prices, and the persistence of output and inflation," Applied Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 43(10), pages 1161-1174.
  13. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2000. "Optimal monetary policy," Working Paper, Federal Reserve Bank of Richmond 00-10, Federal Reserve Bank of Richmond.
  14. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function," NBER Technical Working Papers 0282, National Bureau of Economic Research, Inc.
  15. Kryvtsov, Oleksiy & Midrigan, Virgiliu, 2010. "Inventories and real rigidities in New Keynesian business cycle models," Journal of the Japanese and International Economies, Elsevier, vol. 24(2), pages 259-281, June.
  16. Kenneth D. West, 1985. "A Variance Bounds Test of the Linear Quardractic Inventory Model," NBER Working Papers 1581, National Bureau of Economic Research, Inc.
  17. Krause, M.U. & Lubik, T.A., 2003. "The (Ir)relevance of Real Wage Rigidity in the New Keynesian Model with Search Frictions," Discussion Paper, Tilburg University, Center for Economic Research 2003-113, Tilburg University, Center for Economic Research.
  18. Aubhik Khan, 2003. "The role of inventories in the business cycle," Business Review, Federal Reserve Bank of Philadelphia, Federal Reserve Bank of Philadelphia, issue Q3, pages 38-45.
  19. Alan S. Blinder & Louis J. Maccini, 1991. "Taking Stock: A Critical Assessment of Recent Research on Inventories," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 5(1), pages 73-96, Winter.
  20. Wen, Yi, 2002. "Understanding the Inventory Cycle," Working Papers, Cornell University, Center for Analytic Economics 02-04, Cornell University, Center for Analytic Economics.
  21. Aubhik Khan & Julia K. Thomas, 2007. "Inventories and the Business Cycle: An Equilibrium Analysis of ( S, s ) Policies," American Economic Review, American Economic Association, American Economic Association, vol. 97(4), pages 1165-1188, September.
  22. Louis J. Maccini & Adrian Pagan, 2006. "Inventories, Fluctuations and Business Cycles. Working paper #4," NCER Working Paper Series, National Centre for Econometric Research 4, National Centre for Econometric Research.
  23. Louis J. Maccini & Bartholomew J. Moore & Huntley Schaller, 2004. "The Interest Rate, Learning, and Inventory Investment," American Economic Review, American Economic Association, American Economic Association, vol. 94(5), pages 1303-1327, December.
  24. David Lopez-Salido & Andrew T. Levin, 2004. "Optimal Monetary Policy with Endogenous Capital Accumulation," 2004 Meeting Papers, Society for Economic Dynamics 826, Society for Economic Dynamics.
  25. Chang, Yongsung & Hornstein, Andreas & Sarte, Pierre-Daniel, 2009. "On the employment effects of productivity shocks: The role of inventories, demand elasticity, and sticky prices," Journal of Monetary Economics, Elsevier, Elsevier, vol. 56(3), pages 328-343, April.
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Citations

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Cited by:
  1. Lubik, Thomas A. & Teo, Wing Leong, 2012. "Inventories, inflation dynamics and the New Keynesian Phillips curve," European Economic Review, Elsevier, Elsevier, vol. 56(3), pages 327-346.
  2. Teo, Wing Leong, 2011. "Inventories and optimal monetary policy in a small open economy," Journal of International Money and Finance, Elsevier, Elsevier, vol. 30(8), pages 1719-1748.
  3. repec:mar:magkse:201123 is not listed on IDEAS
  4. Marcel Förster, 2013. "The Great Moderation: Inventories, Shocks or Monetary Policy?," MAGKS Papers on Economics, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung) 201348, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).

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