Inventories and Optimal Monetary Policy

Thomas Lubik and Wing Leong Teo

No 2009-33, School of Economics and Public Policy Working Papers from University of Adelaide, School of Economics and Public Policy

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.

Keywords: Ramsey policy; New Keynesian model (search for similar items in EconPapers)
JEL-codes: E24 E32 J64 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2009
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Related works:
Working Paper: Inventories and Optimal Monetary Policy (2010)
Journal Article: Inventories and optimal monetary policy (2009)
Working Paper: Inventories and Optimal Monetary Policy (2009)
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