2012 Reports

Can news shocks account for the business-cycle dynamics of inventories?

Crouzet, Nicolas; Oh, Hyunseung

The procyclicality of inventory investment is a central feature of US business cycles. As such, it provides a test for the recent literature on news shocks, which argues that anticipated changes in fundamentals are important sources of aggregate fluctuations. We show that, in a range of inventory models, anticipated shocks to fundamentals generate booms of a peculiar kind: consumption and investment increase, but inventories fall persistently. During these booms, production and inventory investment are dominated by intertemporal substitution, as firms satisfy sales out of inventory stock and delay production until the realization of the anticipated shock. This mechanism is surprisingly difficult to overturn. We derive analytical parameter restrictions which guarantee procyclical inventory dynamics in response to news shocks, and show that standard calibrations considered in the literature do not come close to satisfying the restrictions. Furthermore, the introduction of the frictions studied by the news literature, such as variable capacity utilization and adjustment costs, is not sufficient to restore the procyclicality of inventories. We use the models' restrictions on the comovement of sales and inventories to identify news shocks in postwar US data. We find that the identified shock leads to a diffusion in TFP, but has a short implementation lag and accounts for a small fraction of long-run movements in TFP, inventories and sales.