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Inventory Shocks and the Great Moderation

Inventory Shocks and the Great Moderation 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 toward 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. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Money, Credit and Banking Wiley

Inventory Shocks and the Great Moderation

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References (32)

Publisher
Wiley
Copyright
Copyright © 2016 The Ohio State University
ISSN
0022-2879
eISSN
1538-4616
DOI
10.1111/jmcb.12315
Publisher site
See Article on Publisher Site

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 toward 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.

Journal

Journal of Money, Credit and BankingWiley

Published: Jun 1, 2016

Keywords: ; ; ; ; ; ;

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