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Inventories and the Business Cycle: An Equilibrium Analysis of ( S, s ) Policies

  • Aubhik Khan
  • Julia K. Thomas

We develop an equilibrium business cycle model where nonconvex delivery costs lead firms to follow (S, s) inventory policies. Calibrated to postwar US data, the model reproduces two-thirds of the cyclical variability of inventory investment. Moreover, it delivers strongly procyclical inventory investment, greater volatility in production than sales, and a countercyclical inventory-to-sales ratio. Our model challenges several prominent claims involving inventories, including the widely held belief that they amplify aggregate fluctuations. Despite the comovement between inventory investment and final sales, GDP volatility is essentially unaltered by inventory accumulation, because procyclical inventory investment diverts resources from final production, thereby dampening fluctuations in sales. (JEL E22, E32).

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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 97 (2007)
Issue (Month): 4 (September)
Pages: 1165-1188

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Handle: RePEc:aea:aecrev:v:97:y:2007:i:4:p:1165-1188
Note: DOI: 10.1257/aer.97.4.1165
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  1. Christiano, Lawrence J., 1988. "Why does inventory investment fluctuate so much?," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 247-280.
  2. Brad R Humphreys & Louis J Maccini & Scott Schuh, 1997. "Input and Output Inventories," Economics Working Paper Archive 391, The Johns Hopkins University,Department of Economics.
  3. 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.
  4. Krusell, P & Smith Jr, A-A, 1995. "Income and Wealth Heterogeneity in the Macroeconomic," RCER Working Papers 399, University of Rochester - Center for Economic Research (RCER).
  5. Aubhik Khan & Julia K. Thomas, . "Nonconvex Factor Adjustments in Equilibrium Business Cycle Models: Do Nonlinearities Matter?," GSIA Working Papers 2000-E33, Carnegie Mellon University, Tepper School of Business.
  6. Eichenbaum, Martin, 1989. "Some Empirical Evidence on the Production Level and Production Cost Smoothing Models of Inventory Investment," American Economic Review, American Economic Association, vol. 79(4), pages 853-64, September.
  7. Mark Bils & James A. Kahn, 1999. "What inventory behavior tells us about business cycles," Staff Reports 92, Federal Reserve Bank of New York.
  8. Scott Schuh, 1996. "Evidence on the link between firm-level and aggregate inventory behavior," Finance and Economics Discussion Series 96-46, Board of Governors of the Federal Reserve System (U.S.).
  9. Ricardo J. Caballero & Eduardo M.R.A. Engel, 1994. "Explaining Investment Dynamics in U.S. Manufacturing: A Generalized (S,s) Approach," NBER Working Papers 4887, National Bureau of Economic Research, Inc.
  10. Robert G. King & Sergio T. Rebelo, 2000. "Resuscitating Real Business Cycles," RCER Working Papers 467, University of Rochester - Center for Economic Research (RCER).
  11. Rogerson, Richard, 1988. "Indivisible labor, lotteries and equilibrium," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 3-16, January.
  12. Ramey, Valerie A, 1989. "Inventories as Factors of Production and Economic Fluctuations," American Economic Review, American Economic Association, vol. 79(3), pages 338-54, June.
  13. repec:oup:restud:v:67:y:2000:i:1:p:117-45 is not listed on IDEAS
  14. Caballero, Ricardo J & Engel, Eduardo M R A, 1991. "Dynamic (S, s) Economies," Econometrica, Econometric Society, vol. 59(6), pages 1659-86, November.
  15. Hall, George & Rust, John, 2000. "An empirical model of inventory investment by durable commodity intermediaries," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 52(1), pages 171-214, June.
  16. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  17. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
  18. Alan S. Blinder & Louis J. Maccini, 1991. "Taking Stock: A Critical Assessment of Recent Research on Inventories," Journal of Economic Perspectives, American Economic Association, vol. 5(1), pages 73-96, Winter.
  19. Per Krusell & Anthony A. Smith, Jr., . "Income and Wealth Heterogeneity, Portfolio Choice, and Equilibrium Asset Returns," GSIA Working Papers 1997-45, Carnegie Mellon University, Tepper School of Business.
  20. 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.
  21. Caplin, Andrew S, 1985. "The Variability of Aggregate Demand with (S, s) Inventory Policies," Econometrica, Econometric Society, vol. 53(6), pages 1395-1409, November.
  22. Jonathan McCarthy & Egon Zakrajsek, 2000. "Microeconomic inventory adjustment: evidence from U.S. firm-level data," Staff Reports 101, Federal Reserve Bank of New York.
  23. James H. Stock & Mark W. Watson, 2003. "Has the business cycle changed?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 9-56.
  24. Terry J. Fitzgerald, 1997. "Inventories and the business cycle: an overview," Economic Review, Federal Reserve Bank of Cleveland, issue Q III, pages 11-22.
  25. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Staff Report 102, Federal Reserve Bank of Minneapolis.
  26. Daniele Coen-Pirani, 2003. "Microeconomic Inventory Behavior and Aggregate Inventory Dynamics," GSIA Working Papers 2003-E28, Carnegie Mellon University, Tepper School of Business.
  27. Eric J. Bartelsman & Wayne Gray, 1996. "The NBER Manufacturing Productivity Database," NBER Technical Working Papers 0205, National Bureau of Economic Research, Inc.
  28. Andreas Hornstein, 1998. "Inventory investment and the business cycle," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 49-71.
  29. Alan S. Blinder, 1981. "Retail Inventory Behavior and Business Fluctuations," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(2), pages 443-520.
  30. Kahn, James A, 1987. "Inventories and the Volatility of Production," American Economic Review, American Economic Association, vol. 77(4), pages 667-79, September.
  31. repec:oup:qjecon:v:106:y:1991:i:4:p:1267-86 is not listed on IDEAS
  32. Valerie A. Ramey & Daniel J. Vine, 2005. "Tracking the source of the decline in GDP volatility: an analysis of the automobile industry," Finance and Economics Discussion Series 2005-14, Board of Governors of the Federal Reserve System (U.S.).
  33. repec:cup:macdyn:v:1:y:1997:i:2:p:387-422 is not listed on IDEAS
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