The effect of economic uncertainty on inventory and working capital for manufacturing firms

Abstract

This paper develops an empirical model to investigate the impact of macro-economic risk on working capital and the various types of inventory. Our analysis helps manufacturing firms anticipate the implications of high macro-economic risk, measured through the economic policy uncertainty (EPU) index, on their operations. Using a sample of 6503 US manufacturing firms during the period 1990–2018, we show that EPU drives high levels of inventory, thus corroborating existing theories about random disruptions raising safety-stock levels. We also show that increased economic uncertainty yields higher trade credits, payables, and working capital, thus requiring firms to tie more capital to their operations. Our results are statistically significant, yet these effects are small at the firm level. The results are robust when applying the monetary policy uncertainty (MPU) index to the subsample of the data from 1990 to 2007, instead of the EPU index to the same data set.