The ISIR session at the ASSA meetings in Chicago, Illinois took place on January 7, 2012, and was entitled “Inventories and Business Cycles.”  Presiding was James A. Kahn of Yeshiva University (who also organized the session).  The following papers were presented at the session:

“The Response of Capital Goods Shipments to Demand over the Business Cycle: A Stylized Fact and Some Potential Explanations” by Jeremy Nalewaik and Eugenio Pinto (Federal Reserve Board)

This paper studies the behavior of producers of capital goods, examining how they set shipments in response to fluctuations in new orders. The paper establishes a stylized fact: the response of shipments to orders is more pronounced when the level of orders is low relative to the level of shipments, which typically occurs when orders plunge in recessions. This cyclical change in firm behavior is quantitatively important, accounting for a large portion of the steep decline in equipment investment in the last two recessions. We provide economic interpretations of this stylized fact using models where the production decisions of firms are guided by a target ratio of unfilled orders to shipments. We show that cyclical variation in that target may help explain some of the changes in firm behavior, and using a production smoothing model, we show that time variation in the persistence of the orders growth process is probably a large part of the story as well. Finally, we examine whether an (S, s) adjustment model can help explain our empirical results.

Discussant: Jon Willis (Federal Reserve Bank of Kansas City)

“Lumpy Investment, Lumpy Inventories” by Rudiger Bachmann and Lin Ma (University of Michigan)

We reevaluate the claim in Khan and Thomas (2008) that fixed capital adjustment costs are irrelevant for aggregate dynamics. We augment a standard lumpy investment model with non-convex adjustment costs for fixed capital to include another channel of consumption smoothing: inventories. This extra channel of saving breaks the tight link between consumption and fixed investment. We find that when capital investment is no longer the mirror image of consumption, volatility and persistence of aggregate variables change with the fixed capital adjustment costs in the expected direction: investment volatility is dampened and persistence increased.

Discussant: Francois Gourio (Boston University)

“When Do Inventories Destabilize the Economy? A Tractable Approach to (S,s) Policies” by Pengfei Wang (Hong Kong Science and Technology University), Yi Wen (FRB St. Louis), and Zhiwei Xu (Tsinghua Univ)

Conventional wisdom has it that inventory investment destabilizes the economy because it is procyclical to sales. Khan and Thomas (2007) show that the conventional wisdom is wrong in a general equilibrium (S,s) model with capital. We argue that their finding is not robust—the conventional wisdom can still hold in general equilibrium if firms can adjust output by varying the capacity utilization rate. Our result also holds true if there exist investment adjustment costs. Unlike the existing (S,s) inventory literature that relies on the Krusell-Smith (1998) numerical solution methods, we characterize (S,s) inventory policies in closed form despite the large state space in our general equilibrium model. Standard log-linearization methods can be used to solve the model and generate impulse response functions.

Discussant: Daniele Coen-Pirani (University of Pittsburgh)

“Durable Goods Production and Inventory Dynamics: An Application to the Automobile Industry” by Adam Copeland (Federal Reserve Bank of New York) and James A. Kahn (Yeshiva University)

This paper develops a model of the joint determination of production, inventories and pricing of a monopolistically competitive durable good producer. The model gives rise to time-varying markups that interact with the inventory-sales ratio, even with flexible prices. Maximum likelihood estimation with automobile industry data yields plausible parameter estimates and impulse responses. We then apply the model to analyze the impact of the “Cash-for-Clunkers” program, and find that the model predicts a negligible production response; essentially all the action is inventories. This leads us to consider evidence of threshold effects that imply a stronger response very far from the steady state. This results in a modest but more plausible production response to the policy–still small in comparison to the sales impact, but now at least measurable. Even with some production response, the results still provide a cautionary tale for countercyclical policies that rely on stimulating consumer spending. Even an impact on spending need not translate into a comparable impact on employment and output.

Discussant: Pierre-Daniel Sarte (Federal Reserve Bank of Richmond)

Denver, January 2011

Presentation (15 minutes each)

Discussion (10 minutes each)

1) “A Unified Solution to Inventory Puzzles,” by Louis J. Maccini, Bartholomew Moore, and Huntley Schaller

Discussant: James Kahn

Abstract: There are two important sets of puzzles about inventories. The first set might be called the “traditional puzzles.” First, there is the variance ratio puzzle. If production costs are convex, then firms want to smooth production in response to demand shocks. This implies that production should vary less than sales. It doesn’t. Second, there is the slow adjustment puzzle. As an influential survey of the inventory literature puts it, “One major difficulty with stock-adjustment models is that adjustment speeds generally turn out to be extremely low; the estimated adjustment speed is often less than 10 percent per month. This is implausible when even the widest swings in inventory stocks amount to no more than a few days of production. [Blinder and Maccini (1991, page 81)]” Finally, there is the input cost puzzle. When costs are low, firms have an incentive to produce more and build up their inventories. It has been surprisingly difficult, however, to find evidence of an empirical relationship between observable costs and inventories. The second set of puzzles arises out of the relationship between monetary policy and inventories. First, the mechanism puzzle. Monetary policy changes the interest rate and should affect inventories, since the interest rate represents the opportunity cost of holding inventories. In fact, VAR studies find that monetary policy affects inventories. But 40 years of empirical research on inventories has generally failed to find any significant effect of the interest rate on inventories. Second, the sign puzzle. Expansionary monetary policy lowers the interest rate. A decline in the interest rate should increase inventories, because a lower interest rate reduces the opportunity cost of holding inventories. VAR studies find that the short-term effect of an expansionary monetary policy is just the opposite — inventories decrease. Third, the timing puzzle. Monetary policy induces transitory changes in the interest rate. The effect of monetary policy on the interest rate largely disappears within one year. But inventories begin to fall only after the transitory shock to the interest rate has largely dissipated. In this paper, we use non-stationary econometrics to abstract from the high-frequency noise in the data. We construct a model that incorporates several economic mechanisms but is tractable enough to be linearized around stationary magnitudes. We then calibrate structural parameters using coefficient estimates from the cointegrating regression. Using the resulting structural parameters and the decision rule from the model we analyze and provide a unified explanation for all of these empirical puzzles.

2) “Inventories in Motion: A New Approach to Inventories over the Business Cycle” by Michael McMahon

Discussant: Thomas Lubik (Richmond Fed)

Abstract: I examine those inventories which arise naturally in the gaps between the production of goods and their consumption (distribution inventories) as well as a simple storage motive. Though these are technically difficult to embed in a general equilibrium business cycle model, I overcome these difficulties using a non-linear solution algorithm. Simulating a monthly model, I aggregate the data to a quarterly frequency and find that the inventories model matches the aggregate data well. I then consider whether changes in the management of inventories by firms in the last 25 years, such as the so-called “Walmart Approach”, may have caused the coincident decline in the volatility of GDP growth – the Great Moderation. Mapping the salient features of the improvements in inventory management, such as cheaper and faster distribution of goods, into the parameters of my model, I find little role for improved inventory management in explaining the decline in macroeconomic volatility. While the inventory management changes are useful to match aspects of the changes in inventory behaviour over the last 25 years, I conclude that the “Good Luck” hypothesis, namely, the idea that the decline in macroeconomic volatility is simply related to smaller and/or less frequent macroeconomic shocks, is a much more likely explanation for falling variance of GDP growth.”

3) “Negative investment in China: restructuring and financing constraints versus growth,” by Sai Ding (University of Glasgow), Alessandra Guariglia (Durham University), John Knight (University of Oxford)

Discussant: Kaiji Chen (Hong Kong University )

Abstract: This paper attempts to address the seemingly puzzle of China’s investment pattern: despite the high aggregate investment, a high rate of negative investment is found at the microeconomic level. Using a large firm-level dataset, we test three hypotheses of negative investment among various ownership groups: the financing explanation, the efficiency explanation, and the growth explanation. Our panel data Probit estimation shows that the negative investment by state-owned firms can be explained mainly by inefficiency: owing to over-investment or mis-investment in the past, these firms need to restructure and get rid of obsolete capital in the face of increasing competition and hardening budgets. The financing explanation holds for private firms, which may have to divest in order to raise capital. Rapid economic growth counterweighs both effects in all types of firms.

4) “Investment, irreversibility, and financing constraints in transition economies,”  by Alessandra Guariglia, John Tsoukalas, and Serafeim Tsoukas

Discussant: George Hall (Brandeis University)

Abstract: Using a panel of 4223 Bulgarian, Czech, Polish, and Romanian firms, over the period 1998-2005, we show that financially constrained firms likely to face irreversibility constraints exhibit low and insignificant sensitivities of investment to cash flow. These firms typically use their cash flow to accumulate cash instead of investing. Our findings provide a new explanation for why some financially constrained firms may exhibit low investment-cash flow sensitivities. Specifically, controlling for investment irreversibility may matter for the interpretation of these sensitivities.

Download the summary of the 2010 ISIR  session.

The International Society for Inventory Research (ISIR) sponsors a session each year at the ASSA Meetings in January.  Historically, these sessions have focused exclusively on the topic of inventories.  At next year’s session, however, the focus will be expanded to include the related topics of business fixed investment and business cycles.

January 3-5, Atlanta, GA, USA

The International Society for Inventory Research (ISIR) sponsors a session each year at the ASSA Meetings in January. Historically, these sessions have focused exclusively on the topic of inventories.  At next year’s session, however, the focus will be expanded to include the related topics of business fixed investment and business cycles.

Jan. 3, 2:30 pm, Atlanta Marriott Marquis, M105 – ISIR

Inventories, Investment and Aggregate Fluctuations (E2)

Presiding: AUBHIK KHAN (Ohio State University)

The Cross-section of Firms over the Business Cycle: New Facts and a DSGE Exploration

RUEDIGER BACHMANN (University of Michigan)

CHRISTIAN BAYER (IGIER, Universita Bocconi)

Estimating Firm-Level Risk

FRANCES GOURIO (Boston University)

Input and Output Inventories in the UK

JOHN D. TSOUKALAS (University of Nottingham)

Time-to-Build and the Seasonal Fluctuations

SATYAJIT CHATTERJEE (Federal Reserve Bank of Philadelphia)

B. RAVIKUMAR (University of Iowa)

The ISIR session at the ASSA Meetings in San Francisco, CA took place on January 3, 2009 and was entitled “Topics in Inventory Research”. Presiding was Louis J. Maccini of Johns Hopkins University (who also organized the session). The following papers were presented at the the session:

“Input and Output inventory Dynamics”by Yi Wen, Federal Reserve Bank of St. Louis

This paper develops an analytically-tractable general-equilibrium model of inventory dynamics based on a precautionary stockout-avoidance motive. The model’s predictions are broadly consistent with the U.S. business cycle and key features of inventory behavior, including (i) a large inventory stock-to-sales ratio and a small inventory investment-to-sales ratio in the long run, (ii) excess volatility of production relative to sales, (iii) procyclical inventory investment but countercyclical stock-to-sales ratio over the business cycle, and (iv) more volatile input inventories than output inventories. It is also shown that technological improvement of inventory management (that eliminates production/ordering lags) can increase, rather than decrease, the volatility of aggregate output. Key to this seemingly counter-intuitive result is that a stockout- avoidance motive leads to procyclical liquidity-value of inventories (hence, procyclical relative prices of output), which acts as an automatic stabilizer that discourages final sales in a boom and encourages final sales during a recession, thereby reducing the variability of GDP.

Discussant: Scott Schuh, Federal Reserve Bank of Boston

“Inventories, Monetary Policy, and the Market for New Automobiles” by  Adam Copeland, Bureau of Economic Analysis,  George Hall, Brandeis University and Louis Maccini, Johns Hopkins University

This paper investigates the effects of monetary policy on the market for new automobiles. A representative automobile firm is modeled as a dynamic profit-maximizer who is a monopolistic competitor and holds large quantities of inventories in order to facilitate sales.  The model of the firm is used to develop a market-equilibrium model that determines the price and quantity of new cars and light trucks.  Our market-equilibrium model is estimated using quarterly micro-level data on new cars and light trucks.  Monetary policy of course changes interest rates.  Increases in interest rates dampen sales through two channels. First, higher interest rates raise the cost to the firm of holding inventories; as the firm economizes on its inventory holdings, consumer find it more difficult to be matched with their preferred vehicle and fewer sales are consummated. Second, higher interest rates raise the cost to consumers of purchasing a new vehicle on credit.  We find both channels to be quantitatively important.

Discussant: James Kahn, University of Pennsylvania

“Inventories, Lumpy Trade, and Large Devaluations” by George Alessandria, Federal Reserve Bank of Philadelphia,  Joseph Kaboski, Ohio State University, and Virgiliu Midrigan, New York University

Fixed transaction costs and delivery lags are important costs of international trade. These costs lead firms to import infrequently and hold substantially larger inventories of imported goods than domestic goods. Using multiple sources of data, we document these facts. We then show that a parsimoniously parameterized model economy with importers facing an (S, s)-type inventory management problem successfully accounts for these features of the data. Moreover, the model can account for import and import price dynamics in the aftermath of large devaluations. In particular, desired inventory adjustment in response to a sudden, large increase in the relative price of imported goods creates a short-term trade implosion, an immediate, temporary drop in the value and number of distinct varieties imported, as well as a slow increase in the retail price of imported goods. Our study of 6 current account reversals following large devaluation episodes in the last decade provide strong support for the model’s predictions.

Discussant: Aubhik Khan, Ohio State University

The ISIR session entitled “Recent Advances in Inventory Research” at the ASSA Meetings in New Orleans, LA, took place on Friday, January 4. Andreas Hornstein of the Federal Reserve Bank of Richmond organized the session and presided. The following papers were presented.

“Durable Goods Inventories and the Great Moderation,” by James A. Kahn, Federal Reserve Bank of New York

The so-called “Great Moderation” was not an across-the-board uniform reduction in volatility, but was heavily concentrated in the durable goods sector. This paper presents evidence of the role of inventories in that sector’s stabilization, and then provides a model that is consistent with the facts in that sector as well as with anecdotal accounts of improved inventory management. The key innovation in the model is to apply the idea of stockout-avoidance to a production-to-order industry, which best characterizes the durable goods sector. The key technological advance is characterized by a reduced lead time on materials orders. Numerical examples suggest that the mechanism of the model is capable of delivering reductions in the volatility of both output and sales that are on the order of magnitude of those observed in the data.

Discussant: Elena Pesavento (Emory University)

“Input-Output Inventories and the Great Moderation,” by Ana Maria Herrera, Michigan State University, Zheng Liu (Emory University), and Elena Pesavento (Emory University)

In recent years, interest in assessing the contribution of inventory behavior to the Great Moderation has spurred a line of inquiry into various empirical features of inventory investment. Despite this broad empirical literature, there is only a limited number of theoretical studies that model inventories in a quantitative dynamic stochastic general equilibrium (DSGE) setting. We build a model in which the production of a final good goes through multiple stages, but in which individuals optimize. In the model, a firm at the first stage uses labor as an input, while a firm at a later stage uses all outputs produced at the previous stage. A representative household consumes a basket of goods produced at the final stage and supplies labor to firms at the first stage. Our model is a dynamic extension of Blanchard and Kiyotaki (1987) featuring monopolistic competition in goods markets and in labor markets, in which imperfectly competitive firms set nominal prices for differentiated goods and imperfectly competitive households set nominal wages for differentiated labor skills. The model has the additional features that a composite of the differentiated goods can serve either as a final consumption good or as an intermediate input for the production of the differentiated goods (Huang and Liu, 2004), and that inventories enter the production function of intermediate and final goods.

The model also includes a monetary authority, which allows us to explore the role of better policy in explaining changes in the business cycle.

Discussant: Scott Schuh, Federal Reserve Bank of Boston

“Oil Shocks, Segment Shifts, and Capacity Utilization in the U.S. Automobile Industry: What has changed in 30 Years,” by Valerie A. Ramey (University of California, San Diego) and Daniel J. Vine (Federal Reserve Board)

Between 2002 and 2006, the average price of gasoline in the United States increased more than two fold after having risen only modestly in the preceding 15 years. Much like the episodes of fuel price escalation in the 197 0s and early 1 980s, the recent increase caused a shift in auto demand away from heavy vehicles towards more fuel efficient models. While the marketplace for new autos and the flexibility of production technology have evolved in many ways since the 1970s, the disruptions to motor vehicle output caused by the most recent sectoral shift were in many ways similar to thedisruptions observed 30 years ago. Using detailed industry data, we show that the misalignment between supply and demand across vehicle market segments was about as large after 2002 as it was in the early 1970s and early 1980s. Capacity utilization declined after each of these episodes, and, controlling for differences in the business cycle in each episode, the magnitude of the decline attributable to the shifts in the composition of demand was about the same. Finally, we find that the adjustments made to production capacity since 2002 were similar to the adjustments made in the 1980s, when shifts in demand were judged as being permanent.

Discussant: George Hall, Brandeis University

International Society for Inventory Research (ISIR) session

at the January 2008 ASSA convention in New Orleans, LA.

Session Title: Recent Advances in Inventory Research

Presiding: Andreas Hornstein, Federal Reserve Bank of Richmond

Paper: “Inventories and the Great Moderation Revisited”

James Kahn (Federal Reserve Bank of New York),

Discussant: Elena Pesavento (Emory University)

Paper: “Production Chains and the Business Cycles: A Model of Input and Output Inventories”

Ana Maria Herrera (Michigan State University), Zheng Liu (Emory University), Elena Pesavento (Emory University)

Discussant: Scott Schuh, Federal Reserve Bank of Boston

Paper: “Segment Shifts and Capacity Utilization in the U.S. Automobile Industry: What has changed in 30 years?”

Valerie A. Ramey (University of California San Diego) – Daniel J. Vine (Federal Reserve Board),

Discussant: George Hall, Brandeis University

Andreas Hornstein

Research Department

Federal Reserve Bank of Richmond

PO Box 27622

Richmond VA 23261-7622

Phone: (804) 697-8266

Fax: (804) 697-8217, 697-2662

e-mail: andreas.hornstein@rich.frb.org

web page: http://www.richmondfed.org/research/research_economists/andreas_hornstein.cfm

ISIR Session at the Allied Social Science Meetings

In Chicago, IL, January 5-7, 2007

The ISIR session entitled “Recent Advances in Inventory Research” at the ASSA Meetings in Chicago , IL took place Saturday, January 6. George Hall of Brandeis University organized the session and presided. The following papers were presented:

“Inventory Turnover and Product Variety” by Howard P. Marvel and James Peck, The Ohio State University .

This paper studies the powerful incentives retailers face to limit their inventories, leading them to focus on inventory turn as a performance measure. Retailers’ desire to pare inventory holding costs yield a misalignment of their incentives with those of a supplier seeking to have a broad line of products held. The authors identify the source of the vertical misalignment, demonstrating its impact on product variety. The authors then consider a series of vertical restraints that can potentially correct the problem and use the analysis to explain the otherwise puzzling behavior of suppliers in several recent U.S. antitrust cases.

Discussant: Adam Copeland, Bureau of Economic Analysis

“Long-Run Inventory Responses to Changes in Interest Rates: A Stage of Fabrication Approach” by David Bivin, Indiana University Purdue University Indianapolis

In this paper, the author examines the relationship between inventories (both finished goods and work-in-progress) and long-run movements of the real interest rate in build-to-order industries. Using data at the 2-digit SIC level, the author finds that in about half the industries studied inventories at all levels of production fall when the economy transitions from a low-interest rate regime to a high-interest rate regime.

Discussant: Huntley Schaller, Carleton University

“Monetary Policy Shocks, Inventory Dynamics, and Price Setting Behavior” by Yongseung Jung, Kyunghee University, and Tack Yun, Board of Governors of the Federal Reserve System.

In this paper, the authors incorporate a productive role for inventories into the new-Keynesian framework for modeling the macroeconomy. First the authors estimate a VAR model demonstrating that an unexpected rise in the Federal Funds rate is associated with a decrease in the ratio of sales-to-stocks as well as an increase in finished good inventories. Second, within an optimizing model with staggered price setting the authors assume holding finished inventories helps firms generate more sales. Using this model, the authors show that they can replicate this observed relationship between monetary shocks and finished good inventories as well as derive a new-Keynesian-style Phillips Curve.

Discussant: Youngsung Chang, Seoul National University