Inventory investment and output volatility

Abstract

This paper reports the results of a detailed examination of the hypothesis that improved inventory management and production techniques are responsible for the decline in the volatility of U.S. GDP growth. Our innovations are to look at the data at a finer level of disaggregation than previous studies, to exploit cross-sectional heterogeneity to obtain clearer identification of this hypothesis, and to provide a complete decomposition of the change in GDP volatility. At the aggregate level, changes in inventory behavior can account directly for almost half of the total reduction in GDP volatility. However, reduced volatility of sales and lower covariance among the output of major sectors in the economy each account for more than one-fourth of the reduction in GDP volatility. Improved inventory management appears to be associated loosely with lower volatility at the industry level.