Inventory Shocks and the Great Moderation

43 Pages Posted: 17 Oct 2012 Last revised: 7 Jul 2015

See all articles by James Morley

James Morley

University of Sydney

Aarti Singh

The University of Sydney - School of Economics

Date Written: June 26, 2015

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

JEL Classification: E32, E22, C32

Suggested Citation

Morley, James and Singh, Aarti, Inventory Shocks and the Great Moderation (June 26, 2015). UNSW Business School Research Paper No. 2012-42B. Available at SSRN: https://ssrn.com/abstract=2162272 or http://dx.doi.org/10.2139/ssrn.2162272

James Morley (Contact Author)

University of Sydney ( email )

Rm 370 Merewether (H04)
Sydney, NSW 2006 2008
Australia

HOME PAGE: http://https://sites.google.com/site/jamescmorley/

Aarti Singh

The University of Sydney - School of Economics ( email )

Rm 370 Merewether (H04)
Sydney, NSW 2006 2008
Australia

HOME PAGE: http://sydney.edu.au/arts/economics/staff/academic/aarti_singh.shtml

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