Working Paper: NBER ID: w10078
Authors: Aubhik Khan; Julia Thomas
Abstract: We develop an equilibrium business cycle model where nonconvex delivery costs lead producers of final goods to follow generalized (S,s) inventory policies with respect to intermediate goods. When calibrated to match the average inventory-to-sales ratio in postwar U.S. data, our model reproduces two-thirds 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. Our model contradicts this view. Despite the positive correlation between sales and inventory investment, we find that inventory accumulation has minimal consequence for the cyclical variability of GDP. In equilibrium, procyclical inventory investment diverts resources from the production of final goods; thus, it dampens cyclical changes in final sales, leaving GDP volatility essentially unaltered. Moreover, although business cycles arise solely from shocks to productivity and markets are perfectly competitive in our model, it nonetheless yields a countercyclical inventory-to-sales ratio.
Keywords: Inventory Investment; Business Cycle; Equilibrium Model
JEL Codes: E32; E22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| procyclical inventory accumulation (E22) | dampens cyclical changes in final sales (E32) |
| increased inventory investment (E22) | reduces the volatility of GDP (E20) |
| improvements in inventory management (M11) | do not significantly alter GDP volatility (E39) |
| procyclical inventory investment (E22) | does not lead to increased GDP volatility (E39) |
| trade-offs in resource allocation between inventory investment and final sales (G31) | crucial for understanding overall impact on GDP volatility (E20) |