Optimal Price and Inventory Adjustment in an Open-Economy Model of the Business Cycle

64 Pages Posted: 19 Jun 2004 Last revised: 25 Jun 2010

See all articles by Robert P. Flood

Robert P. Flood

International Monetary Fund (IMF) - Research Department; CENTRUM Business School; National Bureau of Economic Research (NBER)

Robert J. Hodrick

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Date Written: March 1983

Abstract

This paper develops an open-economy macroeconomic model which can be used to interpret the observed fluctuations in output, inventories,prices,and exchange rates in the medium-sized economies of the world. The model is consistent with the major empirical regularities that have been discovered in studies of business cycles as closed-economy phenomena and in empirical studies of prices and exchange rates. The empirical regularities are (i) changes in the nominal money supply cause real output fluctuations, (ii) deviations of output from a "natural rate" show persistence, (iii)exchangerates are more volatile than nominal prices of goods, and (iv) depreciations of the currency coincide with deteriorations of the terms of trade. A controversial aspect of the model is that only unperceived money has real effects. The channel through which these effects arise involves a misperception by rational maximizing firms of the true demand that they will face after having set prices. The firms learn about their environment from equilibrium asset prices, and the dynamics of the model reflect the optimal response of inventory-holding firms rather than ad hoc price dynamics.

Suggested Citation

Flood, Robert P. and Hodrick, Robert J., Optimal Price and Inventory Adjustment in an Open-Economy Model of the Business Cycle (March 1983). NBER Working Paper No. w1089. Available at SSRN: https://ssrn.com/abstract=304817

Robert P. Flood (Contact Author)

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-7667 (Phone)
202-623-6339 (Fax)

CENTRUM Business School

Daniel Alomía Robles s/n
Los Alamos de Monterrico
Surco, Lima, Lima 00001
Peru

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Robert J. Hodrick

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

365 Fifth Avenue, 5th Floor
New York, NY 10016-4309
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
16
Abstract Views
609
PlumX Metrics