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The Interest Rate Learning and Inventory Investment

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Author Info
Bartholomew Moore
Louis J Maccini
Huntley Schaller

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Abstract

Economic theory predicts a negative relationship between inventories and the real interest rate, but previous empirical studies (mostly based on the older stock adjustment model) have found little evidence of such a relationship. We derive parametric tests for the role of the interest rate in specifications based on the firm’s optimization problem. These Euler equation and decision rule tests mirror earlier evidence, finding little role for the interest rate. We present a simple and intuitively appealing explanation, based on regime switching in the real interest rate and learning, of why tests based on the stock adjustment model, the Euler equation, and the decision rule ?all of which emphasize short-run fluctuations in inventories and the interest rate ?are unlikely to uncover a relationship. Our analysis suggests that inventories will not respond much to short-run fluctuations in the interest rate, but they should respond to long-run movements (regime shifts; e.g., between low real rates in the 1970s and high rates in the early 1980s). Both simple and sophisticated tests confirm our predictions and show a highly significant long-run relationship between inventories and the interest rate, with an elasticity of about -1.5. Furthermore, a formal model of our explanation yields a distinctive, testable implication. This implication is supported by the data.

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Paper provided by The Johns Hopkins University,Department of Economics in its series Economics Working Paper Archive with number 512.

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Date of creation: Dec 2002
Date of revision: Apr 2004
Handle: RePEc:jhu:papers:512

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  6. Robert E. Carpenter & Steven M. Fazzari & Bruce C. Petersen, 1994. "Inventory Investment, Internal-Finance Fluctuation, and the Business Cycle," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 25(1994-2), pages 75-138. [Downloadable!]
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  9. Kashyap, Anil K & Lamont, Owen A & Stein, Jeremy C, 1994. "Credit Conditions and the Cyclical Behavior of Inventories," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 565-92, August. [Downloadable!] (restricted)
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  10. 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. [Downloadable!] (restricted)
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  13. Rossana, R J, 1993. "The Long-Run Implications of the Production Smoothing Model of Inventories: An Empirical Test," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 8(3), pages 295-306, July-Sept. [Downloadable!] (restricted)
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  15. 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. [Downloadable!] (restricted)
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  24. Fuhrer, Jeffrey C. & Moore, George R. & Schuh, Scott D., 1995. "Estimating the linear-quadratic inventory model Maximum likelihood versus generalized method of moments," Journal of Monetary Economics, Elsevier, vol. 35(1), pages 115-157, February. [Downloadable!] (restricted)
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  27. Robert E. Carpenter & Steven M. Fazzari & Bruce C. Petersen, 1994. "Inventory (Dis)Investment, Internal Finance Fluctuations, and the Business Cycle," Macroeconomics 9401001, EconWPA. [Downloadable!]
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  31. 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. [Downloadable!] (restricted)
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    Other versions:
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Steven J. Davis & James A. Kahn, 2008. "Interpreting the Great Moderation: changes in the volatility of economic activity at the macro and micro Levels," Staff Reports 334, Federal Reserve Bank of New York. [Downloadable!]
    Other versions:
  2. Schaller, Huntley, 2006. "Econometric Issues in Estimating User Cost Elasticity," Economics Series 194, Institute for Advanced Studies. [Downloadable!]
  3. Junayed, Sadaquat & Khan, Hashmat, 2009. "Inventory Investment and the Real Interest Rate," Economics Discussion Papers 2009-23, Kiel Institute for the World Economy. [Downloadable!]
    Other versions:
  4. Daniel Leigh, 2005. "Estimating the Implicit Inflation Target: An Application to U.S. Monetary Policy," IMF Working Papers 05/77, International Monetary Fund. [Downloadable!]
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