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Inventories, Markups and Real Rigidities in Sticky Price Models of the Canadian Economy

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  • Oleksiy Kryvtsov
  • Virgiliu Midrigan

Abstract

Recent New Keynesian models of macroeconomy view nominal cost rigidities, rather than nominal price rigidities, as the key feature that accounts for the observed persistence in output and inflation. Kryvtsov and Midrigan (2010a,b) reassess these conclusions by combining a theory based on nominal rigidities and storable goods with direct evidence on inventories for the U.S. This paper applies Kryvtsov and Midrigan’s model to the case of Canada. The model predicts that if costs of production are sticky and markups do not vary much in response to, say, expansionary monetary policy, firms react by excessively accumulating inventories in anticipation of future cost increases. In contrast, in the Canadian data inventories are fairly constant over the cycle and in response to changes in monetary policy. Similarly to Kryvtsov and Midrigan, we show that markups must decline sufficiently in times of a monetary expansion in order to reduce firms’ incentive to hold inventories and thus bring the model’s inventory predictions in line with the data. The model consistent with salient features of the dynamics of inventories in the Canadian data implies that countercyclical markups account for a sizable (50-80%) fraction of the response of real variables to monetary shocks.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 11-9.

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Length: 42 pages
Date of creation: 2011
Date of revision:
Handle: RePEc:bca:bocawp:11-9

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Keywords: Business fluctuations and cycles; Transmission of monetary policy;

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References

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  1. Basu, Susanto, 1995. "Intermediate Goods and Business Cycles: Implications for Productivity and Welfare," American Economic Review, American Economic Association, vol. 85(3), pages 512-31, June.
  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. Oleksiy Kryvtsov & Peter J. Klenow, 2004. "State-Dependent or Time-Dependent Pricing: Does It Matter For Recent U.S. Inflation?," Computing in Economics and Finance 2004 277, Society for Computational Economics.
  4. Emi Nakamura & Jón Steinsson, 2010. "Monetary Non-Neutrality in a Multisector Menu Cost Model," The Quarterly Journal of Economics, MIT Press, vol. 125(3), pages 961-1013, August.
  5. 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.
  6. Bils, M. & Kahn, J.A., 1996. "What Inventory Behavior Tells Us About Business Cycles," RCER Working Papers 428, University of Rochester - Center for Economic Research (RCER).
  7. Oleksiy Kryvtsov & Virgiliu Midrigan, 2009. "Inventories, Markups, and Real Rigidities in Menu Cost Models," NBER Working Papers 14651, National Bureau of Economic Research, Inc.
  8. Mikhail Golosov & Robert E. Lucas, 2003. "Menu Costs and Phillips Curves," NBER Working Papers 10187, National Bureau of Economic Research, Inc.
  9. Oleksiy Kryvtsov & Yang Zhang, 2010. "Inventories in ToTEM," Discussion Papers 10-9, Bank of Canada.
  10. Christopher L. House, 2008. "Fixed Costs and Long-Lived Investments," NBER Working Papers 14402, National Bureau of Economic Research, Inc.
  11. Stephen Murchison & Andrew Rennison, 2006. "ToTEM: The Bank of Canada's New Quarterly Projection Model," Technical Reports 97, Bank of Canada.
  12. Oleksiy Kryvtsov & Virgiliu Midrigan, 2009. "Inventories and Real Rigidities in New Keynesian Business Cycle Models," Working Papers 09-9, Bank of Canada.
  13. Oleksiy Kryvtsov & Yang Zhang, 2010. "Inventories, Stockouts, and ToTEM," Discussion Papers 10-8, Bank of Canada.
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