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Understanding the Inventory Cycle: I. Partial Equilibrium Analysis

  • Wen, Yi

    (Cornell U)

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Careful examination of aggregate data from the U.S. and other OECD countries reveals that production and inventory behavior exhibit paradoxical features: 1) Inventory investment is strongly countercyclical at very high frequencies (e.g., 2-3 quarters per cycle); it is procyclical only at relatively low cyclical frequencies such as the business-cycle frequencies (e.g., 8-40 quarters per cycle). 2) Production is less volatile than sales around the high frequencies; it is more volatile than sales only around business-cycle or lower frequencies. 3) Unlike capital investment or GDP, the bulk of the variance of inventory investment is concentrated around high frequencies rather than around business-cycle frequencies. These features of production and inventory behavior at the low and high frequencies provide a litmus test for inventory theories. This paper shows that the stockout-avoidance theory (Kahn, AER 1987) has a much better potential than any other competing theories for explaining the seemingly paradoxical features of inventory fluctuations observed at different cyclical frequencies. My analysis suggests that demand shocks are the source of the business cycle.

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Paper provided by Cornell University, Center for Analytic Economics in its series Working Papers with number 03-08.

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Date of creation: Jun 2003
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Handle: RePEc:ecl:corcae:03-08
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  1. Blanchard, Olivier J, 1983. "The Production and Inventory Behavior of the American Automobile Industry," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 365-400, June.
  2. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  3. Andrew B. Abel, 1985. "Inventories, Stock-Outs, and Production Smoothing," NBER Working Papers 1563, National Bureau of Economic Research, Inc.
  4. Christiano, Lawrence J., 1988. "Why does inventory investment fluctuate so much?," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 247-280.
  5. Fisher, Jonas D M & Hornstein, Andreas, 2000. "(S, s) Inventory Policies in General Equilibrium," Review of Economic Studies, Wiley Blackwell, vol. 67(1), pages 117-45, January.
  6. 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.
  7. Mark Bils & James Kahn, 1998. "What inventory behavior tells us about business cycles," Research Paper 9817, Federal Reserve Bank of New York.
  8. 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.
  9. 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.
  10. 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.
  11. Maccini, Louis J & Zabel, Edward, 1996. "Serial Correlation in Demand, Backlogging and Production Volatility," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 37(2), pages 423-52, May.
  12. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : I. The basic neoclassical model," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 195-232.
  13. Martin S. Eichenbaum, 1988. "Some Empirical Evidence on the Production Level and Production Cost Smoothing Models of Inventory Investment," NBER Working Papers 2523, National Bureau of Economic Research, Inc.
  14. Kahn, James A, 1987. "Inventories and the Volatility of Production," American Economic Review, American Economic Association, vol. 77(4), pages 667-79, September.
  15. 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.
  16. Martin Feldstein & Alan Auerbach, 1976. "Inventory Behavior in Durable-Goods Manufacturing: The Target-Adjustment Model," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 7(2), pages 351-408.
  17. Long, John B, Jr & Plosser, Charles I, 1983. "Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 39-69, February.
  18. Blinder, Alan S, 1982. "Inventories and Sticky Prices: More on the Microfoundations of Macroeconomics," American Economic Review, American Economic Association, vol. 72(3), pages 334-48, June.
  19. Deaton, A. & Laroque, G., 1989. "On The Behavior Of Commodity Prices," Papers 145, Princeton, Woodrow Wilson School - Development Studies.
  20. 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.
  21. Amihud, Yakov & Mendelson, Haim, 1983. "Price Smoothing and Inventory," Review of Economic Studies, Wiley Blackwell, vol. 50(1), pages 87-98, January.
  22. Chow, Gregory C., 1997. "Dynamic Economics: Optimization by the Lagrange Method," OUP Catalogue, Oxford University Press, number 9780195101928, March.
  23. Andreas Hornstein, 1998. "Inventory investment and the business cycle," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 49-71.
  24. Wen, Yi, 2002. "Fickle Consumers versus Random Technology: Explaining Domestic and International Comovements," Working Papers 02-01, Cornell University, Center for Analytic Economics.
  25. Kahn, James A, 1992. "Why Is Production More Volatile Than Sales? Theory and Evidence on the Stockout-Avoidance Motive for Inventory-Holding," The Quarterly Journal of Economics, MIT Press, vol. 107(2), pages 481-510, May.
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