School of Economics

2010 Discussion Papers

School of Economics Discussion Paper 10/05
April 2010

Inventories in Dynamic General Equilibrium

Katsuyuki Shibayama
University of Kent at Canterbury

Abstract:

This article investigates a dynamic general equilibrium model with a stockout constraint, which means that no seller can sell more than the inventories that she has. The model successfully explains two inventory facts; (i) inventory investment is procyclical, and (ii) production is more volatile than sales. The key intuition is that, since inventories and demand are complements in generating sales, the optimal level of inventories is increasing in expected demand. Thus, when demand is expected to be strong, firms increase their production not only to meet their demand but also to accumulate inventories. Also, our model shows that the inventory to sales ratio is persistent and countercyclical, while the (endogenous) markup is countercyclical. These are because a high interest rate in booms discourages firms to hold inventories.

JEL Classification: E32, C68

Keywords: Inventory investment, Inventory cycles, Stockout constraint, Dynamic stochastic general equilibrium model

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