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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. Yongseung Jung & Tack Yun, 2005. "Monetary policy shocks, inventory dynamics, and price-setting behavior," Working Paper Series 2006-02, Federal Reserve Bank of San Francisco.
  2. Oleksiy Kryvtsov & Virgiliu Midrigan, 2009. "Inventories and Real Rigidities in New Keynesian Business Cycle Models," Working Papers 09-9, Bank of Canada.
  3. Oleksiy Kryvtsov & Virgiliu Midrigan, 2009. "Inventories, Markups, and Real Rigidities in Menu Cost Models," Working Papers 09-6, Bank of Canada.
  4. Aubhik Khan & Julie K. Thomas, 2003. "Inventories and the business cycle: an equilibrium analysis of (S,s) policies," Staff Report 329, Federal Reserve Bank of Minneapolis.
  5. Peter J. Klenow & Oleksiy Kryvtsov, 2005. "State-Dependent or Time-Dependent Pricing: Does it Matter for Recent U.S. Inflation?," NBER Working Papers 11043, National Bureau of Economic Research, Inc.
  6. Stephen Murchison & Andrew Rennison, 2006. "ToTEM: The Bank of Canada's New Quarterly Projection Model," Technical Reports 97, Bank of Canada.
  7. Susanto Basu, 1994. "Intermediate Goods and Business Cycles: Implications for Productivity and Welfare," NBER Working Papers 4817, National Bureau of Economic Research, Inc.
  8. Oleksiy Kryvtsov & Yang Zhang, 2010. "Inventories in ToTEM," Discussion Papers 10-9, Bank of Canada.
  9. Jon Steinsson & Emi Nakamura, 2007. "Monetary Non-Neutrality in a Multi-Sector Menu Cost Model," 2007 Meeting Papers 736, Society for Economic Dynamics.
  10. Mark Bils & James A. Kahn, 1999. "What Inventory Behavior Tells Us About Business Cycles," NBER Working Papers 7310, National Bureau of Economic Research, Inc.
  11. Robert Lucas & Mike Golosov, 2004. "Menu Costs and Phillips Curves," 2004 Meeting Papers 144, Society for Economic Dynamics.
  12. Christopher L. House, 2008. "Fixed Costs and Long-Lived Investments," NBER Working Papers 14402, National Bureau of Economic Research, Inc.
  13. Oleksiy Kryvtsov & Yang Zhang, 2010. "Inventories, Stockouts, and ToTEM," Discussion Papers 10-8, Bank of Canada.
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