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

Listed author(s):
  • 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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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.97.4.1165
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File URL: http://www.aeaweb.org/aer/data/sept07/20031097_data.zip
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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. Prescott, Edward C., 1986. "Theory ahead of business-cycle measurement," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 11-44, January.
  2. Rogerson, Richard, 1988. "Indivisible labor, lotteries and equilibrium," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 3-16, January.
  3. Terry J. Fitzgerald, 1997. "Inventories and the business cycle: an overview," Economic Review, Federal Reserve Bank of Cleveland, issue Q III, pages 11-22.
  4. repec:cup:macdyn:v:1:y:1997:i:2:p:387-422 is not listed on IDEAS
  5. James A. Kahn & Mark Bils, 2000. "What Inventory Behavior Tells Us about Business Cycles," American Economic Review, American Economic Association, vol. 90(3), pages 458-481, June.
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  7. Krusell, Per & Smith, Anthony A., 1997. "Income And Wealth Heterogeneity, Portfolio Choice, And Equilibrium Asset Returns," Macroeconomic Dynamics, Cambridge University Press, vol. 1(02), pages 387-422, June.
  8. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
  9. 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.
  10. Eric J. Bartelsman & Wayne Gray, 1996. "The NBER Manufacturing Productivity Database," NBER Technical Working Papers 0205, National Bureau of Economic Research, Inc.
  11. Jonathan McCarthy & Egon Zakrajsek, 2000. "Microeconomic inventory adjustment: evidence from U.S. firm-level data," Finance and Economics Discussion Series 2000-24, Board of Governors of the Federal Reserve System (U.S.).
  12. Humphreys, Brad R. & Maccini, Louis J. & Schuh, Scott, 2001. "Input and output inventories," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 347-375, April.
  13. Jonas D. M. Fisher & Andreas Hornstein, 2000. "(S, s) Inventory Policies in General Equilibrium," Review of Economic Studies, Oxford University Press, vol. 67(1), pages 117-145.
  14. Daniele Coen-Pirani, 2003. "Microeconomic Inventory Behavior and Aggregate Inventory Dynamics," GSIA Working Papers 2003-E28, Carnegie Mellon University, Tepper School of Business.
  15. Ricardo J. Caballero & Eduardo M. R. A. Engel, 1999. "Explaining Investment Dynamics in U.S. Manufacturing: A Generalized (S,s) Approach," Econometrica, Econometric Society, vol. 67(4), pages 783-826, July.
  16. Per Krusell & Anthony A. Smith & Jr., 1998. "Income and Wealth Heterogeneity in the Macroeconomy," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 867-896, October.
  17. Caballero, Ricardo J & Engel, Eduardo M R A, 1991. "Dynamic (S, s) Economies," Econometrica, Econometric Society, vol. 59(6), pages 1659-1686, November.
  18. 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 853-864, September.
  19. Andreas Hornstein, 1998. "Inventory investment and the business cycle," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 49-71.
  20. Valerie A. Ramey & Daniel J. Vine, 2004. "Tracking the Source of the Decline in GDP Volatility: An Analysis of the Automobile Industry," NBER Working Papers 10384, National Bureau of Economic Research, Inc.
  21. Kahn, James A, 1987. "Inventories and the Volatility of Production," American Economic Review, American Economic Association, vol. 77(4), pages 667-679, September.
  22. 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.
  23. Patricia C. Mosser, 1991. "Trade Inventories and (S,s)," The Quarterly Journal of Economics, Oxford University Press, vol. 106(4), pages 1267-1286.
  24. Ramey, Valerie A, 1991. "Nonconvex Costs and the Behavior of Inventories," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 306-334, April.
  25. Caplin, Andrew S, 1985. "The Variability of Aggregate Demand with (S, s) Inventory Policies," Econometrica, Econometric Society, vol. 53(6), pages 1395-1409, November.
  26. Khan, Aubhik & Thomas, Julia K., 2003. "Nonconvex factor adjustments in equilibrium business cycle models: do nonlinearities matter?," Journal of Monetary Economics, Elsevier, vol. 50(2), pages 331-360, March.
  27. 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.).
  28. Ramey, Valerie A, 1989. "Inventories as Factors of Production and Economic Fluctuations," American Economic Review, American Economic Association, vol. 79(3), pages 338-354, June.
  29. King, Robert G. & Rebelo, Sergio T., 1999. "Resuscitating real business cycles," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 14, pages 927-1007 Elsevier.
  30. 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.
  31. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-1370, November.
  32. 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.
  33. Christiano, Lawrence J., 1988. "Why does inventory investment fluctuate so much?," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 247-280.
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