Staff Working Paper No. 1,153
By Diego Rodrigues and Tim Willems
By setting interest rates, monetary policy affects the cost of carrying inventories – giving rise to a 'cost-of-carry channel' of monetary policy transmission. Via a simple model, we show that higher inventory carrying costs drive firms, especially those holding larger inventories, to cut their prices. We test this hypothesis using data from the US goods, housing, and oil markets – finding robust evidence supporting the cost-of-carry channel. We then introduce this channel into a New Keynesian setup and show that it makes optimal policy more focused on inflation stabilisation when inventories are more plentiful – the reason being that the central bank faces a more favourable sacrifice ratio in such an environment.
Inventories matter for the transmission of monetary policy: uncovering the cost-of-carry channel
