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Understanding the Inventory Cycle: I. Partial Equilibrium Analysis

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  • Wen, Yi

    (Cornell U)

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Abstract

Careful examination of aggregate data from the U.S. and other OECD countries reveals that production and inventory behavior exhibit paradoxical features: 1) Inventory investment is strongly countercyclical at very high frequencies (e.g., 2-3 quarters per cycle); it is procyclical only at relatively low cyclical frequencies such as the business-cycle frequencies (e.g., 8-40 quarters per cycle). 2) Production is less volatile than sales around the high frequencies; it is more volatile than sales only around business-cycle or lower frequencies. 3) Unlike capital investment or GDP, the bulk of the variance of inventory investment is concentrated around high frequencies rather than around business-cycle frequencies. These features of production and inventory behavior at the low and high frequencies provide a litmus test for inventory theories. This paper shows that the stockout-avoidance theory (Kahn, AER 1987) has a much better potential than any other competing theories for explaining the seemingly paradoxical features of inventory fluctuations observed at different cyclical frequencies. My analysis suggests that demand shocks are the source of the business cycle.

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Paper provided by Cornell University, Center for Analytic Economics in its series Working Papers with number 03-08.

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Date of creation: Jun 2003
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Handle: RePEc:ecl:corcae:03-08

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  1. Ramey, Valerie A, 1991. "Nonconvex Costs and the Behavior of Inventories," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 306-34, April.
  2. Ricardo J. Caballero & Eduardo M.R.A. Engel, 1994. "Explaining Investment Dynamics in U.S. Manufacturing: A Generalized (S,s) Approach," NBER Working Papers 4887, National Bureau of Economic Research, Inc.
  3. Long, John B, Jr & Plosser, Charles I, 1983. "Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 39-69, February.
  4. Ramey, Valerie A, 1989. "Inventories as Factors of Production and Economic Fluctuations," American Economic Review, American Economic Association, vol. 79(3), pages 338-54, June.
  5. Martin Feldstein & Alan Auerbach, 1976. "Inventory Behavior in Durable-Goods Manufacturing: The Target-Adjustment Model," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 7(2), pages 351-408.
  6. Andreas Hornstein, 1998. "Inventory investment and the business cycle," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 49-71.
  7. Ramey, Valerie A. & West, Kenneth D., 1999. "Inventories," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 13, pages 863-923 Elsevier.
  8. Christiano, Lawrence J., 1988. "Why does inventory investment fluctuate so much?," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 247-280.
  9. Jonas D.M. Fisher & Andreas Hornstein, 1998. "(S,s) Inventory policies in general equilibrium," Working Paper 97-07, Federal Reserve Bank of Richmond.
  10. Martin S. Eichenbaum, 1988. "Some Empirical Evidence on the Production Level and Production Cost Smoothing Models of Inventory Investment," NBER Working Papers 2523, National Bureau of Economic Research, Inc.
  11. Deaton, A. & Laroque, G., 1989. "On The Behavior Of Commodity Prices," Papers 145, Princeton, Woodrow Wilson School - Public and International Affairs.
  12. Alan S. Blinder, 1981. "Inventories and Sticky Prices: More on the Microfoundations of Macroeconomics," NBER Working Papers 0620, National Bureau of Economic Research, Inc.
  13. Olivier J. Blanchard, 1982. "The Production and Inventory Behavior of the American Automobile Industry," NBER Working Papers 0891, National Bureau of Economic Research, Inc.
  14. Humphreys, Brad R. & Maccini, Louis J. & Schuh, Scott, 2001. "Input and output inventories," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 347-375, April.
  15. Abel, Andrew B, 1985. "Inventories, Stock-Outs and Production Smoothing," Review of Economic Studies, Wiley Blackwell, vol. 52(2), pages 283-93, April.
  16. Mark Bils & James A. Kahn, 1999. "What inventory behavior tells us about business cycles," Staff Reports 92, Federal Reserve Bank of New York.
  17. Kahn, James A, 1987. "Inventories and the Volatility of Production," American Economic Review, American Economic Association, vol. 77(4), pages 667-79, September.
  18. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : I. The basic neoclassical model," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 195-232.
  19. Chow, Gregory C., 1997. "Dynamic Economics: Optimization by the Lagrange Method," OUP Catalogue, Oxford University Press, number 9780195101928, September.
  20. Kahn, James A, 1992. "Why Is Production More Volatile Than Sales? Theory and Evidence on the Stockout-Avoidance Motive for Inventory-Holding," The Quarterly Journal of Economics, MIT Press, vol. 107(2), pages 481-510, May.
  21. Wen, Yi, 2002. "Fickle Consumers versus Random Technology: Explaining Domestic and International Comovements," Working Papers 02-01, Cornell University, Center for Analytic Economics.
  22. Maccini, Louis J & Zabel, Edward, 1996. "Serial Correlation in Demand, Backlogging and Production Volatility," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 37(2), pages 423-52, May.
  23. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  24. Alan S. Blinder & Louis J. Maccini, 1991. "Taking Stock: A Critical Assessment of Recent Research on Inventories," Journal of Economic Perspectives, American Economic Association, vol. 5(1), pages 73-96, Winter.
  25. Amihud, Yakov & Mendelson, Haim, 1983. "Price Smoothing and Inventory," Review of Economic Studies, Wiley Blackwell, vol. 50(1), pages 87-98, January.
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