Inventory Mistakes and the Great Moderation
AbstractWhy did the volatility of U.S. real GDP decline by more than the volatility of final sales with the Great Moderation in the mid-1980s? One possible explanation is that firms shifted their inventory behaviour towards a greater emphasis on production smoothing. We investigate the role of inventories in the Great Moderation by estimating an unobserved components model that identifies inventory and sales shocks and their propagation in the aggregate data. Our findings suggest little evidence of increased production smoothing. Instead, a reduction in inventory mistakes explains the excess volatility reduction in output relative to sales. The inventory mistakes are informational errors related to production that must be set in advance and their reduction also helps to explain the changed forecasting role of inventories since the mid-1980s. Our findings provide an optimistic prognosis for the continuation of the Great Moderation despite the dramatic movements in output during the recent economic crisis.
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Bibliographic InfoPaper provided by University of Sydney, School of Economics in its series Working Papers with number 2009-04.
Date of creation: Nov 2009
Date of revision:
inventories; unobserved components model; inventory mistakes; production smoothing; Great Moderation;
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