The Bank of England published Staff Working Paper No. 1,153 by Diego Rodrigues and Tim Willems setting out research on a “cost-of-carry channel” of monetary policy transmission, where changes in interest rates affect firms’ inventory carrying costs and, in turn, pricing decisions. The paper’s central claim is that higher inventory carrying costs encourage firms, particularly those holding larger inventories, to cut prices, implying that inventory conditions can materially shape how monetary policy moves inflation. Using a simple model and empirical tests on US data, the authors report robust evidence that a contractionary monetary policy shock lowers prices more when inventories are higher, including in goods (PCE goods prices interacted with retailers’ inventory-to-sales ratios), housing services (CPI owner’s equivalent rent interacted with home vacancy rates), and oil (WTI prices interacted with petroleum stock measures). They also find that firms economise on inventory holdings following a tightening. The paper then embeds the mechanism in a New Keynesian framework, arguing that when inventories are more plentiful the central bank faces a more favourable sacrifice ratio, making optimal policy more focused on inflation stabilisation. The Bank notes that staff working papers describe research in progress, are published to elicit comments and debate, and do not represent Bank of England policy.
Bank of England 2025-11-01
Bank of England working paper presents evidence that higher inventories amplify the disinflationary effects of monetary tightening
The Bank of England's Staff Working Paper No. 1,153 explores the "cost-of-carry channel" in monetary policy, where interest rate changes affect firms' inventory costs and pricing. The research indicates higher inventory costs lead firms to reduce prices, impacting inflation dynamics. The findings suggest abundant inventories improve the central bank's ability to stabilize inflation with a more favorable sacrifice ratio.