Inventory Shocks and the Great Moderation

James Morley and Aarti Singh

No 2012-42B, Discussion Papers from School of Economics, The University of New South Wales

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 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 estimates provide no support for increased production smoothing. Instead, smaller transitory inventory shocks are responsible for the excess volatility reduction in output compared to sales. These shocks behave like informational errors related to production that must be set in advance and their reduction also helps explain the changed forecasting role of inventories since the mid-1980s. Our findings provide an optimistic prognosis for a continuation of the Great Moderation, despite the dramatic movements in output during the recent economic crisis.

Keywords: Great Moderation; inventories; production smoothing; unobserved components model (search for similar items in EconPapers)
JEL-codes: C32 E22 E32 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2015-06
New Economics Papers: this item is included in nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Journal Article: Inventory Shocks and the Great Moderation (2016)
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