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Monetary policy shocks, inventory dynamics, and price-setting behavior

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Author Info
Yongseung Jung
Tack Yun
Abstract

In this paper, we estimate a VAR model to present an empirical finding that an unexpected rise in the federal funds rate decreases the ratio of sales to stocks available for sales, while it increases finished goods inventories. In addition, dynamic responses of these variables reach their peaks several quarters after a monetary shock. In order to understand the observed relationship between monetary policy and finished goods inventories, we allow for the accumulation of finished goods inventories in an optimizing sticky price model, where prices are set in a staggered fashion. In our model, holding finished inventories helps firms to generate more sales at given their prices. We then show that the model can generate the observed relationship between monetary shocks and finished goods inventories. Furthermore, we find that allowing for inventory holdings leads to a Phillips curve equation, which makes the inflation rate depend on the expected present-value of future marginal cost as well as the current periodicals marginal cost and the expected rate of future inflation.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2006-02.

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Date of creation: 2005
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Handle: RePEc:fip:fedfwp:2006-02

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Related research
Keywords: Business cycles ; Monetary policy ; Phillips curve;

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  1. Andreas Hornstein & Pierre-Daniel Sarte, 2001. "Sticky prices and inventories : production smoothing reconsidered," Working Paper 01-06, Federal Reserve Bank of Richmond.
  2. Woodford, Michael, 2005. "Firm-Specific Capital and the New Keynesian Phillips Curve," MPRA Paper 825, University Library of Munich, Germany. [Downloadable!]
    Other versions:
  3. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January. [Downloadable!] (restricted)
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    Other versions:
  5. Stephanie Schmitt-Grohe & Martin Uribe, 2004. "Optimal Simple and Implementable Monetary and Fiscal Rules," NBER Working Papers 10253, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  6. Valerie A. Ramey & Kenneth D. West, 1997. "Inventories," NBER Working Papers 6315, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
    • Ramey, Valerie A. & West, Kenneth D., 1999. "Inventories," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 13, pages 863-923 Elsevier. [Downloadable!] (restricted)
  7. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February. [Downloadable!] (restricted)
  8. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1998. "Monetary Policy Shocks: What Have We Learned and to What End?," NBER Working Papers 6400, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October. [Downloadable!] (restricted)
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  10. David E. Altig & Lawrence J. Christiano & Martin Eichenbaum & Jesper Linde, 2004. "Firm-specific capital, nominal rigidities, and the business cycle," Working Paper 0416, Federal Reserve Bank of Cleveland. [Downloadable!]
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  11. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  12. Rotemberg, Julio J. & Woodford, Michael, 1999. "The cyclical behavior of prices and costs," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 16, pages 1051-1135 Elsevier. [Downloadable!] (restricted)
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  13. Julio J. Rotemberg & Michael Woodford, 1993. "Dynamic General Equilibrium Models with Imperfectly Competitive Product Markets," NBER Working Papers 4502, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  16. Ramey, Valerie A & Vine, Daniel J, 2004. "Why Do Real and Nominal Inventory-Sales Ratios Have Different Trends?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(5), pages 959-63, October.
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  17. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers 8403, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  18. Yongsung Chang & Andreas Hornstein & Pierre-Daniel G. Sarte, 2004. "Productivity, employment, and inventories," Working Paper 04-09, Federal Reserve Bank of Richmond.
  19. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June. [Downloadable!] (restricted)
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  20. Christiano, Lawrence J., 1988. "Why does inventory investment fluctuate so much?," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 247-280. [Downloadable!] (restricted)
  21. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : I. The basic neoclassical model," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 195-232. [Downloadable!] (restricted)
  22. Lawrence J. Christiano, 1998. "Solving dynamic equilibrium models by a method of undetermined coefficients," Working Paper 9804, Federal Reserve Bank of Cleveland. [Downloadable!]
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