Staggered Prices and Inventories: Production Smoothing Reconsidered

Federal Reserve Bank of Richmond WP No. 98-8

28 Pages Posted: 1 Jul 1999

See all articles by Andreas Hornstein

Andreas Hornstein

Federal Reserve Bank of Richmond

Pierre-Daniel G. Sarte

Federal Reserve Bank of Richmond

Date Written: December 1998

Abstract

Staggered nominal price setting introduces predictable sales variations at the firm level. We study the implications of staggered prices in a framework where, because of increasing marginal cost, firms use inventories to smooth production and thereby separate sales from production. Conventional criticisms of production smoothing models have focused on their inability to replicate the following two stylized facts: (1) production is more volatile than sales, and (2) inventory investment is positively correlated with sales. In contrast, we show that a standard production smoothing model of inventory behavior is consistent with these facts when prices are sticky. Moreover, these results hold irrespective of whether the economy is driven by nominal demand or real supply shocks. It has also been suggested that increasing short run marginal cost at the firm level can make the effects of nominal shocks more persistent. We show that if firms can hold inventories, nominal demand shocks will have persistent effects on sales, but not necessarily on production.

JEL Classification: E13, E22, E31

Suggested Citation

Hornstein, Andreas and Sarte, Pierre-Daniel, Staggered Prices and Inventories: Production Smoothing Reconsidered (December 1998). Federal Reserve Bank of Richmond WP No. 98-8. Available at SSRN: https://ssrn.com/abstract=153477 or http://dx.doi.org/10.2139/ssrn.153477

Andreas Hornstein (Contact Author)

Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States
804-697-8266 (Phone)
804-697-8255 (Fax)

Pierre-Daniel Sarte

Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

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