Productivity, Employment, and Inventories: Smoothing Over Sticky Prices

We present a simple sticky-price model with inventories and show that the employment response to a productivity shock depends crucially on the extent to which goods are storable. If firms hold inventories, then, in response to a favorable cost shock, firms can expand output relative to sales. They would do so to exploit low production costs as well as to increase inventory stocks up to higher anticipated levels of sales. For quantitatively reasonable calibrations, employment increases (decreases) when the depreciation rate on goods in storage is sufficiently low (high) following a productivity shock. We then estimate the employment response to productivity shocks from the disaggregate U.S. manufacturing data from 1958 to 1996. Consistent with our theory we find that an industry's employment response to productivity shift is strongly correlated with the inventory holdings and durability of products in the industry