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Some Empirical Evidence on the Production Level and Production Cost Smoothing Models of Inventory Investment

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  • Eichenbaum, Martin

Abstract

The production smoothing model of inventories has long been the basic paradigm within which empirical research on inventories has been conducted The basic hypothesis embedded In this model IS that inventories of finished goods serve primarily to smooth production levels in the face of fluctuating demand and convex cost functions. However once we allow for shocks to technology and the costs of producing output firms will also use inventories to shift production from periods in which production costs are relatively high to periods in which production costs are relatively low. In this sense inventories can serve to smooth production costs rather production levels. In this paper we examine the empirical plausibility of the production level and production cost smoothing models of inventories. Our basic strategy is to derive and contrast a set of unconditional moment restrictions Implied by these models in a way that minimizes the role of auxiliary assumptions regarding market structure and Industry demand. We find overwhelming evidence against the production level smoothing model and very little evidence against the production cost smoothing mode1 We conclude that the variance of production exceeds the variance of sales in most manufacturing industries because the production cost smoothing role of inventories is quantitatively more important than the production level smoothing role of inventories.

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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 79 (1989)
Issue (Month): 4 (September)
Pages: 853-64

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Handle: RePEc:aea:aecrev:v:79:y:1989:i:4:p:853-64

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  1. Hansen, Lars Peter & Sargent, Thomas J., 1982. "Instrumental variables procedures for estimating linear rational expectations models," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 263-296.
  2. Sargent, Thomas J, 1978. "Estimation of Dynamic Labor Demand Schedules under Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 1009-44, December.
  3. West, Kenneth D., 1983. "A note on the econometric use of constant dollar inventory series," Economics Letters, Elsevier, vol. 13(4), pages 337-341.
  4. Miron, Jeffrey A & Zeldes, Stephen P, 1988. "Seasonality, Cost Shocks, and the Production Smoothing Models of Inventories," Econometrica, Econometric Society, vol. 56(4), pages 877-908, July.
  5. Kahn, James A, 1987. "Inventories and the Volatility of Production," American Economic Review, American Economic Association, vol. 77(4), pages 667-79, September.
  6. Eichenbaum, Martin & Hansen, Lars Peter, 1990. "Estimating Models with Intertemporal Substitution Using Aggregate Time Series Data," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(1), pages 53-69, January.
  7. Eichenbaum, Martin S & Hansen, Lars Peter & Singleton, Kenneth J, 1988. "A Time Series Analysis of Representative Agent Models of Consumption and Leisure Choice under Uncertainty," The Quarterly Journal of Economics, MIT Press, vol. 103(1), pages 51-78, February.
  8. Lawrence J. Christiano & Martin S. Eichenbaum, 1986. "Temporal Aggregation and Structural Inference in Macroeconomics," NBER Technical Working Papers 0060, National Bureau of Economic Research, Inc.
  9. Cumby, Robert E. & Huizinga, John & Obstfeld, Maurice, 1983. "Two-step two-stage least squares estimation in models with rational expectations," Journal of Econometrics, Elsevier, vol. 21(3), pages 333-355, April.
  10. Blinder, Alan S, 1986. "Can the Production Smoothing Model of Inventory Behavior Be Saved?," The Quarterly Journal of Economics, MIT Press, vol. 101(3), pages 431-53, August.
  11. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  12. Alan S. Blinder, 1986. "More on the Speed of Adjustment in Inventory Models," NBER Working Papers 1913, National Bureau of Economic Research, Inc.
  13. Kenneth D. West, 1985. "A Variance Bounds Test of the Linear Quardractic Inventory Model," NBER Working Papers 1581, National Bureau of Economic Research, Inc.
  14. Olivier J. Blanchard, 1982. "The Production and Inventory Behavior of the American Automobile Industry," NBER Working Papers 0891, National Bureau of Economic Research, Inc.
  15. Eichenbaum, Martin, 1983. "A rational expectations equilibrium model of inventories of finished goods and employment," Journal of Monetary Economics, Elsevier, vol. 12(2), pages 259-277.
  16. Peter M. Garber & Robert G. King, 1983. "Deep Structral Excavation? A Critique of Euler Equation Methods," NBER Technical Working Papers 0031, National Bureau of Economic Research, Inc.
  17. Maccini, Louis J & Rossana, Robert J, 1984. "Joint Production, Quasi-Fixed Factors of Production, and Investement in Finished Goods Inventories," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(2), pages 218-36, May.
  18. Eichenbaum, Martin S., 1984. "Rational expectations and the smoothing properties of inventories of finished goods," Journal of Monetary Economics, Elsevier, vol. 14(1), pages 71-96, July.
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