Inventories, sticky prices, and the persistence of output and inflation

Abstract

Post-war business cycle fluctuations of output and inflation are remarkably persistent. Many recent sticky-price models, however, grossly underpredict this persistence. We assess whether adding inventories to a standard sticky-price model raises the persistence of output and inflation. For this addition, we consider a shopping-cost model. In the model, consumers find shopping activities costly, and the cost of shopping depends on the stock of goods available. In this context, producers manage inventories to smooth production and to affect the cost of shopping. We find that the shopping-cost model generates a persistence for output and inflation that matches the persistence observed in the post-1985 US data.