Inventories, Inflation Dynamics, and the New Keynesian Phillips Curve

34 Pages Posted: 15 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

Date Written: January 1, 2010

Abstract

We introduce inventories into an otherwise standard New Keynesian model and study the implications for inflation dynamics. Inventory holdings are motivated as a means to generate sales for demand-constrained firms. We derive various representations of the New Keynesian Phillips curve with inventories and show that one of these specifications is observationally equivalent to the standard model with respect to the behavior of inflation when the model’s cross-equation restrictions are imposed. However, the driving variable in the New Keynesian Phillips curve – real marginal cost – is unobservable and has to be proxied by, for instance, unit labor costs. An alternative approach is to impute marginal cost by using the model’s optimality conditions. We show that the stock-sales ratio is linked to marginal cost. We also estimate these various specifications of the New Keynesian Phillips curve using GMM. We find that predictive power of the inventory-specification at best approaches that of the standard model, but does not improve upon it. We conclude that inventories do not play a role in explaining inflation dynamics within our New Keynesian Phillips curve framework.

Keywords: Phillips curve, GMM, marginal costs, inventories

JEL Classification: E24, E32, J64

Suggested Citation

Lubik, Thomas and Teo, Wing Leong, Inventories, Inflation Dynamics, and the New Keynesian Phillips Curve (January 1, 2010). FRB Richmond Working Paper No. 10-01, Available at SSRN: https://ssrn.com/abstract=2189562 or http://dx.doi.org/10.2139/ssrn.2189562

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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