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The Interest Rate Learning and Inventory Investment

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  • Bartholomew Moore
  • Louis J Maccini
  • Huntley Schaller

Abstract

Economic theory predicts a negative relationship between inventories and the real interest rate, but previous empirical studies (mostly based on the older stock adjustment model) have found little evidence of such a relationship. We derive parametric tests for the role of the interest rate in specifications based on the firm’s optimization problem. These Euler equation and decision rule tests mirror earlier evidence, finding little role for the interest rate. We present a simple and intuitively appealing explanation, based on regime switching in the real interest rate and learning, of why tests based on the stock adjustment model, the Euler equation, and the decision rule ?all of which emphasize short-run fluctuations in inventories and the interest rate ?are unlikely to uncover a relationship. Our analysis suggests that inventories will not respond much to short-run fluctuations in the interest rate, but they should respond to long-run movements (regime shifts; e.g., between low real rates in the 1970s and high rates in the early 1980s). Both simple and sophisticated tests confirm our predictions and show a highly significant long-run relationship between inventories and the interest rate, with an elasticity of about -1.5. Furthermore, a formal model of our explanation yields a distinctive, testable implication. This implication is supported by the data.

Suggested Citation

  • Bartholomew Moore & Louis J Maccini & Huntley Schaller, 2002. "The Interest Rate Learning and Inventory Investment," Economics Working Paper Archive 512, The Johns Hopkins University,Department of Economics, revised Apr 2004.
  • Handle: RePEc:jhu:papers:512
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    References listed on IDEAS

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    Cited by:

    1. Steven J. Davis & James A. Kahn, 2008. "Interpreting the Great Moderation: Changes in the Volatility of Economic Activity at the Macro and Micro Levels," Journal of Economic Perspectives, American Economic Association, vol. 22(4), pages 155-180, Fall.
    2. Jason Barr, 2013. "Skyscrapers And Skylines: New York And Chicago, 1885–2007," Journal of Regional Science, Wiley Blackwell, vol. 53(3), pages 369-391, August.
    3. Schaller, Huntley, 2006. "Econometric Issues in Estimating User Cost Elasticity," Economics Series 194, Institute for Advanced Studies.
    4. Kosacoff, Bernardo & Ramos, Adrián, 2006. "Microeconomic behavior in high uncertainty environments: the case of Argentina," Documentos de Proyectos 101, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL).
    5. Maccini, Louis J. & Moore, Bartholomew & Schaller, Huntley, 2015. "Inventory behavior with permanent sales shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 53(C), pages 290-313.
    6. Junayed, Sadaquat & Khan, Hashmat, 2009. "Inventory investment and the real interest rate," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 3, pages 1-5.
    7. Thomas A. Lubik & Wing Leong Teo, 2009. "Inventories and optimal monetary policy," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 357-382.
    8. Leigh, Daniel, 2008. "Estimating the Federal Reserve's implicit inflation target: A state space approach," Journal of Economic Dynamics and Control, Elsevier, vol. 32(6), pages 2013-2030, June.
    9. Jones, Christopher S. & Tuzel, Selale, 2013. "Inventory investment and the cost of capital," Journal of Financial Economics, Elsevier, vol. 107(3), pages 557-579.
    10. Daniel Leigh, 2005. "Estimating the Implicit Inflation Target; An Application to U.S. Monetary Policy," IMF Working Papers 05/77, International Monetary Fund.

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