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What inventory behavior tells us about business cycles

  • Mark Bils
  • James Kahn

We argue that the behavior of manufacturing inventories provides evidence against models of business cycle fluctuations based on productivity shocks, increasing returns to scale, or favorable externalities, whereas it is consistent with models with short-run diminishing returns. Finished goods inventories move proportionally much less than sales or production over the business cycle, which we show implies procyclical marginal cost and countercyclical price markups. Obvious measures for marginal cost do not show high marginal cost near peaks, as required to rationalize the inventory behavior, because measured factor productivity rises during the peak phase of the cycle. We can better explain the cyclical behavior of inventory holdings by allowing for procyclical factor utilization, the cost of which is internalized by firms but is not contemporaneously reflected in measured wage rates.

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Paper provided by Federal Reserve Bank of New York in its series Research Paper with number 9817.

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Date of creation: 1998
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Handle: RePEc:fip:fednrp:9817
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