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When do inventories destabilize the economy? an analytical approach to (S,s) policies

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  • Pengfei Wang
  • Yi Wen
  • Zhiwei Xu

Abstract

Conventional wisdom has it that inventory investment destabilizes the economy because it is procyclical to sales. Khan and Thomas (2007) show that the conventional wisdom is wrong in a general equilibrium (S,s) model with capital. We argue that their finding is not robust—the conventional wisdom can still hold in general equilibrium if firms can adjust output by varying the capacity utilization rate. Our result also holds true if there exist investment adjustment costs. Unlike the existing (S,s) inventory literature that relies on the Krusell-Smith (1998) numerical solution methods, we characterize (S,s) inventory policies in closed form despite the large state space in our general equilibrium model. Standard log-linearization methods can be used to solve the model and generate impulse response functions.>

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2011-014.

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Date of creation: 2011
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Handle: RePEc:fip:fedlwp:2011-014

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Keywords: Inventories ; Business cycles;

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  1. Daniele Coen-Pirani, 2004. "Markups, Aggregation, and Inventory Adjustment," American Economic Review, American Economic Association, vol. 94(5), pages 1328-1353, December.
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