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The roles of comovement and inventory investment in the reduction of output volatility

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  • F. Owen Irvine
  • Scott Schuh

Abstract

More than 80 percent of the decline in the variance of aggregate output since 1984 is accounted for by a decline in the covariance (and correlation) of output among industries that hold inventories. Using a HAVAR macro model (Fratantoni and Schuh 2003) with only two sectors, manufacturing and trade, we show that this decline in comovement ? and thus much of the Great Moderation in aggregate and industry-level output ? is explained largely by changes in the structural relationships between sectors? sales and inventory investment, rather than by ?good luck.? A small part of the Moderation is explained by structural changes among interest rate parameters, but the case for better monetary policy is complicated by structural changes in the real side of the economy. We also show that the decline in comovement is concentrated in the automobile industry and related industries that are linked by supply and distribution chains. Immediately prior to the Great Moderation, these industries adopted new production and inventory management techniques, which may explain the structural changes.

Suggested Citation

  • F. Owen Irvine & Scott Schuh, 2007. "The roles of comovement and inventory investment in the reduction of output volatility," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
  • Handle: RePEc:fip:fedfpr:y:2007:i:nov:x:19
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    Cited by:

    1. Matteo Iacoviello & Fabio Schiantarelli & Scott Schuh, 2011. "Input And Output Inventories In General Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 52(4), pages 1179-1213, November.
    2. Owyang, Michael T. & Zubairy, Sarah, 2013. "Who benefits from increased government spending? A state-level analysis," Regional Science and Urban Economics, Elsevier, vol. 43(3), pages 445-464.
    3. Vasco Carvalho & Xavier Gabaix, 2013. "The Great Diversification and Its Undoing," American Economic Review, American Economic Association, vol. 103(5), pages 1697-1727, August.
    4. F. Owen Irvine, 2004. "Sales persistence and the reductions in GDP volatility," Working Papers 05-5, Federal Reserve Bank of Boston.
    5. Miles Parker, 2006. "Diverging Trends in Aggregate and Firm-Level Volatility in the UK," Discussion Papers 16, Monetary Policy Committee Unit, Bank of England.
    6. Steven J. Davis & James A. Kahn, 2008. "Interpreting the Great Moderation: Changes in the Volatility of Economic Activity at the Macro and Micro Levels," Journal of Economic Perspectives, American Economic Association, vol. 22(4), pages 155-180, Fall.
    7. Herrera, Ana Mari­a & Murtazashvili, Irina & Pesavento, Elena, 2008. "The comovement in inventories and in sales: Higher and higher," Economics Letters, Elsevier, vol. 99(1), pages 155-158, April.
    8. F. Owen Irvine & Scott Schuh, 2007. "The roles of comovement and inventory investment in the reduction of output volatility," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
    9. Steven J. Davis & James A. Kahn, 2007. "Macroeconomic implications of changes in micro volatility," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
    10. Kevin J. Stiroh, 2009. "Volatility Accounting: A Production Perspective on Increased Economic Stability," Journal of the European Economic Association, MIT Press, vol. 7(4), pages 671-696, June.
    11. Chun, Hyunbae & Kim, Jung-Wook, 2010. "Declining output growth volatility: A sectoral decomposition," Economics Letters, Elsevier, vol. 106(3), pages 151-153, March.
    12. Bivin, David G., 2006. "Industry evidence of enhanced production stability since 1984," International Journal of Production Economics, Elsevier, vol. 103(1), pages 438-448, September.
    13. Bivin, David G., 2008. "Production stability in a supply-chain environment," International Journal of Production Economics, Elsevier, vol. 114(1), pages 265-275, July.

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