Inventories, sticky prices, and the persistence of output and inflation

Abstract

Post-war business cycle fluctuations of output and inflation are remarkably persistent. Many recent sticky-price models, however, grossly underpredict this persistence. We assess whether adding inventories to a standard sticky-price model raises the persistence of output and inflation. For this addition, we consider a shopping-cost model. In the model, consumers find shopping activities costly, and the cost of shopping depends on the stock of goods available. In this context, producers manage inventories to smooth production and to affect the cost of shopping. We find that the shopping-cost model generates a persistence for output and inflation that matches the persistence observed in the post-1985 US data.

Acknowledgements

We are grateful to Alok Johri, Nathalie Moyen, Jack Robles, and Gregor Smith for helpful discussions. We are also grateful to seminar participants at the Canadian Economics Association meetings, HEC Montreal, the University of Colorado, the University of Oklahoma, and anonymous referees. Parts of this article were written while Boileau was visiting the Federal Reserve Bank of Minneapolis. The article previously circulated under the title Inventories, Sticky Prices, and the Propagation of Nominal Shocks. Letendre thanks the Social Science and Humanities Research Council of Canada and the Arts Research Board of McMaster University for financial support.

Notes

¹ Several papers alter the basic monetary business cycle model to explain higher persistence. To enhance the persistence of output, some papers add staggered wage contracts (Erceg, 1997; Andersen, 1998; Edge, 2002; Huang and Liu, 2002), change the demand structure (Bergin and Feenstra, 2000), and alter the production structure (Kiley, 2000; Huang and Liu, 2001). To enhance the persistence of inflation, some papers add monetary policy rules (Ireland, 2001, 2003; Dittmar et al., 2005) and introduce relative real wage concerns (Fuhrer and Moore, 1995; Ben Aissa and Musy, 2007). Finally, to enhance the persistence of both output and inflation, some papers introduce relative real wage concerns (Ascari and Garcia, 2004) and consider habit formation and capacity utilization (Christiano et al., 2005).

² See Bivin (2005) for recent econometric tests of the linear-quadratic and flexible-accelerator models.