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Federal Reserve Bank of New York
Staff Reports
Inventory dynamics and business cycles: what has changed?
Jonathan McCarthy
Egon Zakrajsek
Abstract

By historical standards, the U.S. economy has experienced a period of remarkable stability since the mid-1980s. One explanation attributes the diminished variability of economic activity to information-technology-led improvements in inventory management. Our results, however, indicate that the changes in inventory dynamics since the mid-1980s played a reinforcing - rather than a leading - role in the volatility reduction. A decomposition of the reduction in the volatility of manufacturing output shows that it almost entirely reflects a decline in the variance of the growth contribution of shipments. And although the volatility of total inventory investment has fallen, the decline occurred well before the mid-1980s and was driven by the reduced variability of materials and supplies. Our analysis does show that since the mid-1980s, inventory dynamics have played a role in stabilizing manufacturing production: Inventory "imbalances" are corrected more rapidly, and the quicker response of inventories to aggregate shocks - at all stages of fabrication - buffers production from fluctuations in sales to a greater extent. But more extensive production smoothing and faster dissolution of inventory imbalances appear to be a consequence of changes in the way industry-level sales and aggregate economic activity respond to shocks, rather than a cause of changes in macroeconomic behavior.


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Jonathan McCarthy & Egon Zakrajsek, Inventory dynamics and business cycles: what has changed?, Federal Reserve Bank of New York, Staff Reports 156, 2002.
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Keywords: Inventories ; Business cycles ; Production (Economic theory)
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