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Inventories and Optimal Monetary Policy

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  • Thomas A. Lubik

    ()

  • Wing Leong Teo

    ()

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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Bibliographic Info

Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2010-07.

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Length: 33 pages
Date of creation: Feb 2010
Date of revision:
Handle: RePEc:een:camaaa:2010-07

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  1. Aubhik Khan & Robert King & Alexander L. Wolman, 2002. "Optimal monetary policy," Working Papers 02-19, Federal Reserve Bank of Philadelphia.
  2. Christiano, Lawrence J., 1988. "Why does inventory investment fluctuate so much?," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 247-280.
  3. Thomas A Lubik & Wing Teong Teo, . "Inventories, Inflation Dynamics and the New Keynesian Phillips Curve," Discussion Papers 10/02, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
  4. Fisher, J.D.M. & Hornstein, A., 1995. "(S,s)Inventory Policies in General Equilibrium," UWO Department of Economics Working Papers 9514, University of Western Ontario, Department of Economics.
  5. Kenneth D. West, 1985. "A Variance Bounds Test of the Linear Quardractic Inventory Model," NBER Working Papers 1581, National Bureau of Economic Research, Inc.
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  7. Andrew T. Levin & Alexei Onatski & John C. Williams & Noah Williams, 2005. "Monetary policy under uncertainty in micro-founded macroeconometric models," Working Paper Series 2005-15, Federal Reserve Bank of San Francisco.
  8. Peter N. Ireland, 2004. "Technology Shocks in the New Keynesian Model," NBER Working Papers 10309, National Bureau of Economic Research, Inc.
  9. Stephanie Schmitt-Grohe & Martin Uribe, 2004. "Optimal Simple and Implementable Monetary and Fiscal Rules," NBER Working Papers 10253, National Bureau of Economic Research, Inc.
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  14. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function," Departmental Working Papers 200106, Rutgers University, Department of Economics.
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  16. Thomas Lubik & Michael Krause, 2003. "The (Ir)relevance of Real Wage Rigidity in the New Keynesian Model with Search Frictions," Economics Working Paper Archive 504, The Johns Hopkins University,Department of Economics.
  17. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  18. 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, vol. 56(3), pages 328-343, April.
  19. Louis J. Maccini & Bartholomew J. Moore & Huntley Schaller, 2004. "The Interest Rate, Learning, and Inventory Investment," American Economic Review, American Economic Association, vol. 94(5), pages 1303-1327, December.
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  24. David Lopez-Salido & Andrew T. Levin, 2004. "Optimal Monetary Policy with Endogenous Capital Accumulation," 2004 Meeting Papers 826, Society for Economic Dynamics.
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Cited by:
  1. repec:mar:magkse:201123 is not listed on IDEAS
  2. 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.
  3. Teo, Wing Leong, 2011. "Inventories and optimal monetary policy in a small open economy," Journal of International Money and Finance, Elsevier, vol. 30(8), pages 1719-1748.
  4. Marcel Förster, 2013. "The Great Moderation: Inventories, Shocks or Monetary Policy?," MAGKS Papers on Economics 201348, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).

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