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When Do Inventories Destabilize the Economy? ---A Tractable Approach to (S,s) Policies

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  • Zhiwei Xu

    (Hong Kong University of Science and Technology)

  • Yi Wen
  • pengfei Wang

    (Hong Kong University of Science and Technology)

Abstract

This paper provides a method to analytically (or tractably) solve (S,s) inventory policies in general equilibrium. This solution method can handle large state space with many state variables, such as multiple capital stocks, lagged aggregate investment and consumption, and other predetermined aggregate variables, thus greatly reducing the computation costs of DSGE models with inventories. We use the Khan-Thomas (2007) model to illustrate how standard log-linearization methods can be used to solve various versions of this inventory model and generate impulse response functions. We find that the conventional wisdom that inventory investment destabilizes the economy can still hold in general-equilibrium if firms face investment adjustment costs or can vary the capacity utilization rate.

Suggested Citation

  • Zhiwei Xu & Yi Wen & pengfei Wang, 2012. "When Do Inventories Destabilize the Economy? ---A Tractable Approach to (S,s) Policies," 2012 Meeting Papers 288, Society for Economic Dynamics.
    • Handle: RePEc:red:sed012:288
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