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Modeling Inventories Over the Business Cycle

  • Julia K. Thomas
  • Aubhik Khan


    (Research Federal Reserve Bank of Philadelphia)

We evaluate two leading models of aggregate fluctuations with inventories in general equilibrium: the (S,s) model and the stockout avoidance model. Each is judged by its ability to explain the observed magnitude of inventories in the U.S. economy, alongside other empirical regularities such as the procyclicality of inventory investment and its positive correlation with sales. We find that the (S,s) model is far more consistent with the behavior of aggregate inventories in the postwar U.S. when aggregate fluctuations arise from technology, rather than preference, shocks. The converse holds for the stockout avoidance model. The (S,s) model performs well with respect to the inventory facts and other business cycle regularities. By contrast, the essential risk motive in the stockout avoidance model is insufficient to generate inventory holdings near the data without destroying the model's performance elsewhere, suggesting a fundamental problem in using reduced-form inventory models with stocks rationalized by this motive.

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Paper provided by Society for Economic Dynamics in its series 2005 Meeting Papers with number 182.

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Date of creation: 2005
Date of revision:
Handle: RePEc:red:sed005:182
Contact details of provider: Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA
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  1. Jonas D. M. Fisher & Andreas Hornstein, 1998. "(S,s) Inventory policies in general equilibrium," Working Paper 97-07, Federal Reserve Bank of Richmond.
  2. Alan S. Blinder, 1980. "Inventories and the Structure of Macro Models," NBER Working Papers 0515, National Bureau of Economic Research, Inc.
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  8. Aubhik Khan & Julia Thomas, 2003. "Inventories and the Business Cycle: An Equilibrium Analysis of (S,s) Policies," NBER Working Papers 10078, National Bureau of Economic Research, Inc.
  9. 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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  16. 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.
  17. Ramey, Valerie A & Vine, Daniel J, 2004. "Why Do Real and Nominal Inventory-Sales Ratios Have Different Trends?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(5), pages 959-63, October.
  18. 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.
  19. James H. Stock & Mark W. Watson, 2003. "Has the business cycle changed?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 9-56.
  20. Kahn, James A, 1987. "Inventories and the Volatility of Production," American Economic Review, American Economic Association, vol. 77(4), pages 667-79, September.
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