Inventories, Markups, And Real Rigidities In Menu Cost Models

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Executive Summary

Real rigidities that limit the responsiveness of real marginal cost to output are a key ingredient of sticky price models necessary to account for the dynamics of output and inflation. The authors argue here, in the spirit of Bils and Kahn (2000), that the behavior of marginal cost over the cycle is directly related to that of inventories, data on which is readily available. They study a menu cost economy in which firms hold inventories in order to avoid stock outs and to economize on fixed ordering costs. They find that, for low rates of depreciation similar to those in the data, inventories are highly sensitive to changes in the cost of holding and acquiring them over the cycle.

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