Inventories and business Cycles: The story of the last three decades

Although there has been nearly unanimous recognition that inventory cycles are one of the primary drivers of business cycles, surprisingly very few empirical studies have been done to investigate how this relationship has evolved over the years, particularly post-1990. In this study I use Bayesian Time-Varying Parameter framework to investigate changes in reduced-form relationship between business cycles and inventories in the U.S. from 1992 Q1 to 2019 Q2. My estimates show that although the volatility of inventory-to-sales ratios has increased in relation to output, the role played by inventories in generating business cycle fluctuations has diminished significantly over the years. In fact, the time-varying slope coefficient measuring the impact of inventories on output seems to have reached a long-run steady state. I find sufficient empirical evidence in favor of the view that it is not the changes in the U.S. monetary policy alone but the structural transformation of the U.S. economy, together with improved monetary policy making, that has resulted in muted business cycles. In this study I use Bayesian Time-Varying Parameter framework to investigate changes in reduced-form relationship between business cycles and inventories in the U.S. from 1992 Q1 to 2019 Q2. My estimates show that although the volatility of inventory-to-sales ratios has increased in relation to output, the role played by inventories in generating business cycle fluctuations has diminished significantly over the years. In fact, the time-varying slope coefficient measuring the impact of inventories on output seems to have reached a long-run steady state. I find sufficient empirical evidence in favor of the view that it is not the changes in the U.S. monetary policy alone but the structural transformation of the U.S. economy, together with improved monetary policy making, that has resulted in muted business cycles.