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Why does inventory investment fluctuate so much during contractions?

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  • Donald S. Allen
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    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.

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    Bibliographic Info

    Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1994-029.

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    Date of creation: 1994
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    Publication status: Published in Journal of Economic Behavior and Organization, January 1997
    Handle: RePEc:fip:fedlwp:1994-029

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    Keywords: Business cycles ; Inventories;

    References

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    1. Lawrence J. Christiano & Martin Eichenbaum, 1987. "Temporal aggregation and structural inference in macroeconomics," Working Papers 306, Federal Reserve Bank of Minneapolis.
    2. Caplin, Andrew S, 1985. "The Variability of Aggregate Demand with (S, s) Inventory Policies," Econometrica, Econometric Society, vol. 53(6), pages 1395-1409, November.
    3. Kahn, James A, 1987. "Inventories and the Volatility of Production," American Economic Review, American Economic Association, vol. 77(4), pages 667-79, September.
    4. 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.
    5. Lovell, Michael C., 1993. "Simulating the inventory cycle," Journal of Economic Behavior & Organization, Elsevier, vol. 21(2), pages 147-179, June.
    6. Russell Cooper & John C. Haltiwanger, 1990. "Inventories and the Propagation of Sectoral Shocks," NBER Working Papers 2425, National Bureau of Economic Research, Inc.
    7. Valerie A. Ramey & Kenneth D. West, 1997. "Inventories," NBER Working Papers 6315, National Bureau of Economic Research, Inc.
      • 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. Nakamura, Masao & Nakamura, Alice, 1989. "Inventory management behavior of American and Japanese firms," Journal of the Japanese and International Economies, Elsevier, vol. 3(3), pages 270-291, September.
    9. 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.
    10. Mosser, Patricia C, 1991. "Trade Inventories and (S, s)," The Quarterly Journal of Economics, MIT Press, vol. 106(4), pages 1267-86, November.
    11. Robert E. Carpenter & Steven M. Fazzari & Bruce C. Petersen, 1994. "Inventory (Dis)Investment, Internal Finance Fluctuations, and the Business Cycle," Macroeconomics 9401001, EconWPA.
    12. Donald P. Morgan, 1991. "Will just-in-time inventory techniques dampen recessions?," Economic Review, Federal Reserve Bank of Kansas City, issue Mar, pages 21-33.
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