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  4. September 2007
  5. Inventories and the Business Cycle: An Equilibrium Analysis of (S, s) Policies

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

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

  • Aubhik Khan
  • Julia K. Thomas
American Economic Review
vol. 97, no. 4, September 2007
(pp. 1165–1188)
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Abstract

We develop an equilibrium business cycle model where nonconvex delivery costs lead firms to follow (S, s) inventory policies. Calibrated to postwar US data, the model reproduces two-thirds of the cyclical variability of inventory investment. Moreover, it delivers strongly procyclical inventory investment, greater volatility in production than sales, and a countercyclical inventory-to-sales ratio. Our model challenges several prominent claims involving inventories, including the widely held belief that they amplify aggregate fluctuations. Despite the comovement between inventory investment and final sales, GDP volatility is essentially unaltered by inventory accumulation, because procyclical inventory investment diverts resources from final production, thereby dampening fluctuations in sales. (JEL E22, E32).

Citation

Khan, Aubhik, and Julia K. Thomas. 2007. "Inventories and the Business Cycle: An Equilibrium Analysis of (S, s) Policies." American Economic Review, 97 (4): 1165–1188. DOI: 10.1257/aer.97.4.1165

Additional Materials

JEL Classification

  • E22 Capital; Investment; Capacity
  • E32 Business Fluctuations; Cycles