Durable Goods Inventories and the Volatility of Production: Explaining the Less Volatile U.S. Economy

Despite the important role played by durable goods production and inventory investment in the business cycle, theoretical models featuring durable goods inventories are rarely available in the literature. This paper provides a simple dynamic optimization model of durable goods inventories and applies the model to analyzing the behavior of durable goods production and sales. It shows that small change in demand shocks can have large effect on the volatility of production relative to that of sales. The more durable is the good, the stronger the effect is. Calibrated exercise shows that the well documented dramatic reduction of output volatility in the U.S. economy since 1984 may be attributable to a decrease in the persistence of demand shocks. The analysis complements and reinforces the analysis of Ramey and Vine (2003).