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Inventories and the Business Cycle: An Equilibrium Analysis of (S,s) Policies

Aubhik Khan () and Julia Thomas

No 10078, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: E32 E22 (search for similar items in EconPapers)
Date: 2003-11
New Economics Papers: this item is included in nep-dge and nep-mac
Note: EFG
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Published as Aubhik KhanJulia Thomas. “Inventories and the Business Cycle: An Equilibrium Analysis of (S,s) Policies." American Economic Review 97, 4 (2007): 1165-88.

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Related works:
Journal Article: Inventories and the Business Cycle: An Equilibrium Analysis of ( S, s ) Policies (2007) Downloads
Working Paper: Inventories and the business cycle: an equilibrium analysis of (S,s) policies (2004) Downloads
Working Paper: Inventories and the business cycle: an equilibrium analysis of (S,s) policies (2003) Downloads
Working Paper: Inventories and the business cycle: an equilibrium analysis of (S,s) policies (2002) Downloads
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