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Why does inventory investment fluctuate so much during contractions?

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  • Donald S. Allen

Abstract

Inventory investment appears to have a significant impact on the movement of aggregate output during business cycle contractions. Recent empirical evidence has raised doubts about the often used assumption of a buffer-stock/production-smoothing motivation for inventory. Work by Blinder and Maccini suggests that the use of an (S,s), or intermittent adjustment decision rule, better explains the stylized facts of the dynamics of inventory investment. This has led to the focus on the (S,s) as an alternative to production-smoothing. I assume that some agents use the (S,s) adjustment rule while others attempt to smooth production in the face of convex costs and uncertain demand. I simulate the interaction of heterogeneous agents (representing manufacturing, wholesale and retail agents) with different inventory decision rules to demonstrate that the stylized facts can be explained by a disaggregated model with vertical coupling between agents. The simulations find opposite aggregation bias effects for (S,s) agents than for production smoothing agents. In particular, aggregation horizontally across agents and/or temporally decreased the relative variability of production/ordering to sales for (S,s) agents while it increased the relative variability for production smoothing agents. The simulations also revealed synchronization by (S,s) agents when subjected to aggregate shocks. This may explain in some of the asymmetrical characteristics of the business cycle.

Suggested Citation

  • Donald S. Allen, 1994. "Why does inventory investment fluctuate so much during contractions?," Working Papers 1994-029, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:1994-029
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    References listed on IDEAS

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    1. Lovell, Michael C., 1993. "Simulating the inventory cycle," Journal of Economic Behavior & Organization, Elsevier, vol. 21(2), pages 147-179, June.
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    3. Patricia C. Mosser, 1991. "Trade Inventories and (S,s)," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 106(4), pages 1267-1286.
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    5. Giuseppe Bertola & Ricardo J. Caballero, 1990. "Kinked Adjustment Costs and Aggregate Dynamics," NBER Chapters, in: NBER Macroeconomics Annual 1990, Volume 5, pages 237-296, National Bureau of Economic Research, Inc.
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    9. 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.
    10. Donald P. Morgan, 1991. "Will just-in-time inventory techniques dampen recessions?," Economic Review, Federal Reserve Bank of Kansas City, vol. 76(Mar), pages 21-33.
    11. Kahn, James A, 1987. "Inventories and the Volatility of Production," American Economic Review, American Economic Association, vol. 77(4), pages 667-679, September.
    12. Lai, Kon S, 1991. "Aggregation and Testing of the Production Smoothing Hypothesis," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 32(2), pages 391-403, May.
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    Keywords

    Business cycles; Inventories;

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