The responses of prices at different stages of production to monetary policy shocks

This paper examines the responses of prices at different stages of production to an explicitly identified demand shock: a monetary policy shock. The frameworks of Christiano, Eichenbaum, and Evans (1994, 1996) and Sims and Zha (1995b) are used to identify the policy shock as the innovation to the federal funds rate in a VAR. The adjustment of prices at different stages of production is examined by adding three different sets of prices to the basic VAR model: (a) the PPIs for crude materials, intermediate goods, and finished goods; (b) the newer industry-based PPIs of input and output prices for crude, primary, semifinished, finished, and final goods processors; and (c) the input and output price indexes for manufacturing industries constructed by Roberts, Stockton, and Struckmeyer (1994). The analysis shows that, at earlier stages of production, a monetary tightening causes input prices to fall more rapidly and by a larger amount than output prices. This finding would appear to be consistent with a model in which all price changes are subject to menu costs but some chain structure in production gives rise to prices at earlier stages of production moving more than prices at later stages.