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Production, Sales and the Change in Inventories: An Identity that Doesn't Add Up

  • Jeffrey A. Miron
  • Stephen P. Zeldes

In this paper we examine two different measures of monthly production that have been used by economists. The first measure, which we refer to as IP, is the index of industrial production constructed by the Board of Governors of the Federal Reserve. This measure is used extensively in empirical work on the business cycle, as well as by policymakers and others to assess the current state of the economy. The second measure, which we refer to as Y4, is constructed from the accounting identity that output equals sales plus the change in inventories. Sales and inventory data are reported by the Department of Commerce. This measure of output is frequently used to estimate models of inventory accumulation. Theoretically, these two series measure the same underlying economic variable -- the production of goods by firms during the month. We show here that the time series properties of these two series are radically different. We examine means, variances, and serial correlation coefficients of the log growth rates, and show that these statistics differ substantially between the two series. In addition, the cross-correlations between the two seasonally adjusted series range from .7 to .0 and are in most cases less than .4. We then demonstrate the significance of these differences in two ways. First, we estimate a model of white noise measurement error for the two series. The estimates indicate that in 15 out of 20 2-digit industries measurement error accounts for over 40% of the variation in the monthly growth rates of seasonally adjusted industrial production data. Second, we show that the variance bounds results of Blinder’s (1986) study of inventory behavior are partially reversed when the IF rather than the Y4 output measure is used.

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Paper provided by Wharton School Rodney L. White Center for Financial Research in its series Rodney L. White Center for Financial Research Working Papers with number 20-87.

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Handle: RePEc:fth:pennfi:20-87
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  1. Mankiw, N. Gregory & Campbell, John, 1989. "International Evidence on the Persistence of Economic Fluctuations," Scholarly Articles 3224417, Harvard University Department of Economics.
  2. Eichenbaum, Martin S., 1984. "Rational expectations and the smoothing properties of inventories of finished goods," Journal of Monetary Economics, Elsevier, vol. 14(1), pages 71-96, July.
  3. Jeffrey A. Miron & Stephen P. Zeldes, 1987. "Seasonality, Cost Shocks, and the Production Smoothing Model of Inventories," NBER Working Papers 2360, National Bureau of Economic Research, Inc.
  4. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
  5. West, Kenneth D, 1986. "A Variance Bounds Test of the Linear Quadratic Inventory Model," Journal of Political Economy, University of Chicago Press, vol. 94(2), pages 374-401, April.
  6. Reagan, Patricia & Sheehan, Dennis P., 1985. "The stylized facts about the behavior of manufacturers' inventories and backorders over the business cycle: 1959-1980," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 217-246, March.
  7. Alan S. Blinder, 1986. "Can the Production Smoothing Model of Inventory Behavior be Saved?," The Quarterly Journal of Economics, Oxford University Press, vol. 101(3), pages 431-453.
  8. N. Gregory Mankiw & Matthew D. Shapiro, 1986. "News or Noise? An Analysis of GNP Revisions," NBER Working Papers 1939, National Bureau of Economic Research, Inc.
  9. Lichtenberg, Frank R & Griliches, Zvi, 1989. "Errors of Measurement in Output Deflators," Journal of Business & Economic Statistics, American Statistical Association, vol. 7(1), pages 1-9, January.
  10. Alan C. Stockman, 1987. "Sectoral and National Aggregate Disturbances to Industrial Output in Seven European Countries," NBER Working Papers 2313, National Bureau of Economic Research, Inc.
  11. Maccini, Louis J & Rossana, Robert J, 1984. "Joint Production, Quasi-Fixed Factors of Production, and Investement in Finished Goods Inventories," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(2), pages 218-36, May.
  12. West, Kenneth D., 1983. "A note on the econometric use of constant dollar inventory series," Economics Letters, Elsevier, vol. 13(4), pages 337-341.
  13. Kahn, James A, 1987. "Inventories and the Volatility of Production," American Economic Review, American Economic Association, vol. 77(4), pages 667-79, September.
  14. Christopher A. Sims, 1974. "Output and Labor Input in Manufacturing," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 5(3), pages 695-736.
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