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Inventory Mistakes and the Great Moderation

Author

Listed:
  • James Morley

    (University of New South Wales)

  • Aarti Singh

    (University of Sydney)

Abstract

Why did the volatility of U.S. real GDP decline by more than the volatility of final sales with the Great Moderation in the mid-1980s? One possible explanation is that firms shifted their inventory behavior towards a greater emphasis on production smoothing. We investigate the role of inventories in the Great Moderation by estimating an unobserved components model that identifies inventory and sales shocks and their propagation in the aggregate data. Our findings suggest little evidence of increased production smoothing. Instead, a reduction in inventory mistakes explains the excess volatility reduction in output relative to sales. The inventory mistakes are informational errors related to production that must be set in advance and their reduction also helps to explain the changed forecasting role of inventories since the mid-1980s. Our findings provide an optimistic prognosis for the continuation of the Great Moderation despite the dramatic movements in output during the recent economic crisis.

Suggested Citation

  • James Morley & Aarti Singh, 2012. "Inventory Mistakes and the Great Moderation," Discussion Papers 2012-42, School of Economics, The University of New South Wales.
    • Handle: RePEc:swe:wpaper:2012-42
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    File URL: http://research.economics.unsw.edu.au/RePEc/papers/2012-42.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Great Moderation; inventories; production smoothing; informational errors; unobserved components model;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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