Inventories and Optimal Monetary Policy

FRB Richmond Economic Quarterly, Vol. 95, No. 4, Fall 2009, pp. 357-382

26 Pages Posted: 14 Dec 2012

See all articles by Thomas Lubik

Thomas Lubik

Federal Reserve Banks - Federal Reserve Bank of Richmond

Wing Leong Teo

National Taiwan University - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: 2009

Abstract

We introduce inventories into a standard New Keynesian Dynamic Stochastic General Equilibrium 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 de-coupling 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 Ramseyoptimal monetary policy and a monetary policy that maximizes consumer welfare over a set of simple interest rate feedback rules. Surprisingly, we find that in contrast to a model without inventories, Ramsey optimal monetary policy in a model with inventories slightly deviates from complete inflation stabilization, but the welfare differences are minor. Moreover, we also find in line with the existing literature that the application of simple rules comes very close to replicating Ramsey-optimal outcomes.

Suggested Citation

Lubik, Thomas and Teo, Wing Leong, Inventories and Optimal Monetary Policy (2009). FRB Richmond Economic Quarterly, Vol. 95, No. 4, Fall 2009, pp. 357-382, Available at SSRN: https://ssrn.com/abstract=2188480

Thomas Lubik (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

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

Wing Leong Teo

National Taiwan University - Department of Economics ( email )

21 Hsu Chow Road
Taipei, 10020
Taiwan

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