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Inventories and the business cycle: an equilibrium analysis of (S,s) policies

  • Aubhik Khan
  • Julia K. Thomas

The authors develop an equilibrium business cycle model in which final goods producers pursue generalized (S,s) inventory policies with respect to intermediate goods, a consequence of nonconvex factor adjustment costs. Calibrating their model to reproduce the average inventory-to-sales ratio in postwar U.S. data, the authors find that it explains half of the cyclical variability of inventory investment. Moreover, inventory accumulation is strongly procyclical, and production is more volatile than sales, as in the data. The comovement between inventory investment and final sales is often interpreted as evidence that inventories amplify aggregate fluctuations. However, the authors' model economy exhibits a business cycle similar to that of a comparable benchmark without inventories.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 02-20.

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Date of creation: 2002
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Handle: RePEc:fip:fedpwp:02-20
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  1. King, Robert G. & Rebelo, Sergio T., 1999. "Resuscitating real business cycles," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 14, pages 927-1007 Elsevier.
  2. Alan S. Blinder, 1981. "Retail Inventory Behavior and Business Fluctuations," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(2), pages 443-520.
  3. 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.
  4. George J. Hall & John Rust, 1999. "An Empirical Model of Inventory Investment by Durable Commodity Intermediaries," Cowles Foundation Discussion Papers 1228, Cowles Foundation for Research in Economics, Yale University.
  5. 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.
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  7. 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.
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  13. Krusell, Per & Smith, Anthony A., 1997. "Income And Wealth Heterogeneity, Portfolio Choice, And Equilibrium Asset Returns," Macroeconomic Dynamics, Cambridge University Press, vol. 1(02), pages 387-422, June.
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  16. Eric J. Bartelsman & Wayne Gray, 1996. "The NBER Manufacturing Productivity Database," NBER Technical Working Papers 0205, National Bureau of Economic Research, Inc.
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  18. Richard Rogerson, 2010. "Indivisible Labor, Lotteries and Equilibrium," Levine's Working Paper Archive 250, David K. Levine.
  19. Valerie A. Ramey & Daniel J. Vine, 2004. "Tracking the Source of the Decline in GDP Volatility: An Analysis of the Automobile Industry," NBER Working Papers 10384, National Bureau of Economic Research, Inc.
  20. Ricardo J. Caballero & Eduardo M.R.A. Engel, 1994. "Explaining Investment Dynamics in U.S. Manufacturing: A Generalized (S,s) Approach," NBER Working Papers 4887, National Bureau of Economic Research, Inc.
  21. Per Krusell & Anthony A. Smith, Jr., . "Income and Wealth Heterogeneity in the Macroeconomy," GSIA Working Papers 1997-37, Carnegie Mellon University, Tepper School of Business.
  22. Eichenbaum, Martin, 1989. "Some Empirical Evidence on the Production Level and Production Cost Smoothing Models of Inventory Investment," American Economic Review, American Economic Association, vol. 79(4), pages 853-64, September.
  23. Terry J. Fitzgerald, 1997. "Inventories and the business cycle: an overview," Economic Review, Federal Reserve Bank of Cleveland, issue Q III, pages 11-22.
  24. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  25. Scott Schuh, 1996. "Evidence on the link between firm-level and aggregate inventory behavior," Finance and Economics Discussion Series 96-46, Board of Governors of the Federal Reserve System (U.S.).
  26. Aubhik Khan & Julia K. Thomas, . "Nonconvex Factor Adjustments in Equilibrium Business Cycle Models: Do Nonlinearities Matter?," GSIA Working Papers 2000-E33, Carnegie Mellon University, Tepper School of Business.
  27. Jonathan McCarthy & Egon Zakrajsek, 2000. "Microeconomic inventory adjustment: evidence from U.S. firm-level data," Staff Reports 101, Federal Reserve Bank of New York.
  28. Andreas Hornstein, 1998. "Inventory investment and the business cycle," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 49-71.
  29. Mosser, Patricia C, 1991. "Trade Inventories and (S, s)," The Quarterly Journal of Economics, MIT Press, vol. 106(4), pages 1267-86, November.
  30. 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.
  31. Caplin, Andrew S, 1985. "The Variability of Aggregate Demand with (S, s) Inventory Policies," Econometrica, Econometric Society, vol. 53(6), pages 1395-1409, November.
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  33. Daniele Coen-Pirani, 2003. "Microeconomic Inventory Behavior and Aggregate Inventory Dynamics," GSIA Working Papers 2003-E28, Carnegie Mellon University, Tepper School of Business.
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