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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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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.97.4.1165
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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. 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.
  2. 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.).
  3. 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.
  4. Caballero, R.J., 1994. "Explaining Investment Dynamics in U.S. Manufacturing: Generalized (S,s) Approach," Working papers 94-32, Massachusetts Institute of Technology (MIT), Department of Economics.
  5. Andreas Hornstein, 1998. "Inventory investment and the business cycle," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 49-71.
  6. Caplin, Andrew S, 1985. "The Variability of Aggregate Demand with (S, s) Inventory Policies," Econometrica, Econometric Society, vol. 53(6), pages 1395-1409, November.
  7. Rogerson, Richard, 1988. "Indivisible labor, lotteries and equilibrium," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 3-16, January.
  8. Terry J. Fitzgerald, 1997. "Inventories and the business cycle: an overview," Economic Review, Federal Reserve Bank of Cleveland, issue Q III, pages 11-22.
  9. 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.
  10. 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.
  11. 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.
  12. Kahn, James A, 1987. "Inventories and the Volatility of Production," American Economic Review, American Economic Association, vol. 77(4), pages 667-79, September.
  13. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
  14. 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.
  15. George Hall & John Rust, 1999. "An Empirical Model of Inventory Investment by Durable Commodity Intermediaries," Macroeconomics 9904005, EconWPA.
  16. Jonas D.M. Fisher & Andreas Hornstein, 1996. "(S, s) inventory policies in general equilibrium," Working Paper Series, Macroeconomic Issues WP-96-24, Federal Reserve Bank of Chicago.
  17. Per Krusell & Anthony A. Smith, Jr., . "Income and Wealth Heterogeneity in the Macroeconomy," GSIA Working Papers 1997-37, Carnegie Mellon University, Tepper School of Business.
  18. Mosser, Patricia C, 1991. "Trade Inventories and (S, s)," The Quarterly Journal of Economics, MIT Press, vol. 106(4), pages 1267-86, November.
  19. 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.
  20. 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.).
  21. Eric J. Bartelsman & Wayne Gray, 1996. "The NBER Manufacturing Productivity Database," NBER Technical Working Papers 0205, National Bureau of Economic Research, Inc.
  22. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Staff Report 102, Federal Reserve Bank of Minneapolis.
  23. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  24. Christiano, Lawrence J., 1988. "Why does inventory investment fluctuate so much?," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 247-280.
  25. Caballero, R.J. & Engel, E.M.R.A., 1990. "Dynamic (S,S) Economies," Discussion Papers 1990_44, Columbia University, Department of Economics.
  26. 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.
  27. Daniele Coen-Pirani, 2003. "Microeconomic Inventory Behavior and Aggregate Inventory Dynamics," GSIA Working Papers 2003-E28, Carnegie Mellon University, Tepper School of Business.
  28. 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.
  29. 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.
  30. 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.
  31. 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.
  32. 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.
  33. repec:cup:macdyn:v:1:y:1997:i:2:p:387-422 is not listed on IDEAS
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