Discussion Paper Series 2005-E-14

Inventories, Predetermined Prices, and the Effects of Monetary Policy

Ichiro Fukunaga

This paper studies the role of inventories in the propagation of monetary shocks by developing simple dynamic general equilibrium models that assume predetermined prices. Inventories serve as a source of real rigidities, that is, amplify the real effects of monetary policy. I introduce a sales-facilitating motive as well as a production-smoothing motive for holding inventories. Inventories respond procyclically and prices are adjusted gradually to a nominal disturbance only if the sales-facilitating motive is relatively strong; otherwise inventories respond countercyclically and prices are adjusted excessively. I also consider the models that assume that both production and prices are predetermined, in which inventories absorb shocks in an unintended manner. In a case where the decision lag of price setting is longer than that of production, inventories respond countercyclically at first and then move procyclically, which is consistent with the pattern shown in empirical studies.

Keywords: Inventories; Sales-facilitating motive; Nominal and real rigidities; Predetermined prices and production

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2005 Bank of Japan All Rights Reserved.

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