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Monetary Policy Shocks, Inventory Dynamics, and Price-Setting Behavior

  • Jung, YongSeung
  • Yun, Tack
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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 ob- served 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 dependent on the expected present-value of future marginal cost as well as the current period's marginal cost and the expected rate of future inflation.

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Paper provided by Department of Economics, UC Santa Cruz in its series Santa Cruz Department of Economics, Working Paper Series with number qt3sf4q6nn.

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Date of creation: 01 Apr 2005
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Handle: RePEc:cdl:ucscec:qt3sf4q6nn
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  1. Mark Bils & James A. Kahn, 1999. "What inventory behavior tells us about business cycles," Staff Reports 92, Federal Reserve Bank of New York.
  2. Julio J. Rotemberg & Michael Woodford, 1999. "The Cyclical Behavior of Prices and Costs," NBER Working Papers 6909, National Bureau of Economic Research, Inc.
  3. Valerie A. Ramey & Kenneth D. West, 1997. "Inventories," NBER Working Papers 6315, National Bureau of Economic Research, Inc.
    • 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.
  4. 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.
  5. David E. Altig & Lawrence J. Christiano & Martin Eichenbaum & Jesper Linde, 2010. "Firm-specific capital, nominal rigidities and the business cycle," International Finance Discussion Papers 990, Board of Governors of the Federal Reserve System (U.S.).
  6. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
  7. Sbordone, Argia M., 2002. "Prices and unit labor costs: a new test of price stickiness," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 265-292, March.
  8. Valerie A. Ramey & Daniel J. Vine, 2004. "Why Do Real and Nominal Inventory-Sales Ratios Have Different Trends," NBER Working Papers 10703, National Bureau of Economic Research, Inc.
  9. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148 Elsevier.
  10. Woodford, Michael, 2005. "Firm-Specific Capital and the New Keynesian Phillips Curve," MPRA Paper 825, University Library of Munich, Germany.
  11. Jordi Galí & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers 341, Department of Economics and Business, Universitat Pompeu Fabra.
  12. 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.
  13. Lawrence J. Christiano, 1998. "Solving dynamic equilibrium models by a method of undetermined coefficients," Working Paper 9804, Federal Reserve Bank of Cleveland.
  14. 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.
  15. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
  16. Schmitt-Grohé, Stephanie & Uribe, Martín, 2004. "Optimal Simple and Implementable Monetary and Fiscal Rules," CEPR Discussion Papers 4334, C.E.P.R. Discussion Papers.
  17. repec:nbr:nberre:0126 is not listed on IDEAS
  18. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, 07.
  19. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  20. Yongsung Chang & Andreas Hornstein & Pierre-Daniel G. Sarte, 2004. "Productivity, employment, and inventories," Working Paper 04-09, Federal Reserve Bank of Richmond.
  21. Christiano, Lawrence J., 1988. "Why does inventory investment fluctuate so much?," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 247-280.
  22. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : II. New directions," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 309-341.
  23. Jenny Williams & Rosalie Liccardo Pacula & Frank J. Chaloupka & Henry Wechsler, 2001. "Alcohol and Marijuana Use Among College Students: Economic Complements or Substitutes?," NBER Working Papers 8401, National Bureau of Economic Research, Inc.
  24. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  25. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  26. 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.
  27. Andreas Hornstein & Pierre-Daniel G. Sarte, 2001. "Sticky prices and inventories : production smoothing reconsidered," Working Paper 01-06, Federal Reserve Bank of Richmond.
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