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Federal Reserve Bank of Richmond
Working Paper
What Inventory Behavior Tells Us About How Business Cycles Have Changed
Thomas A. Lubik
Pierre-Daniel G. Sarte
Felipe Schwartzman

Beginning in the mid-1980s, the nature of U.S. business cycles changed in important ways, as made evident by distinctive shifts in the comovement and relative volatilities of key economic aggregates. These include labor productivity, hours, output, and inventories. Unlike the widely documented change in absolute volatility over that period, known as the Great Moderation, these shifts in comovement and relative volatilities persist into the Great Recession. To understand these changes, we exploit the fact that inventory data are informative about sources of business cycles. Specifically, they provide additional information relative to aggregate investment regarding firms' intertemporal decisions. In this paper, we show that the "investment wedge" estimated with inventories, unlike previous measures, correlates well with established independent measures of credit market frictions. Furthermore, contrary to previous findings, our generalized investment wedge informed by inventory behavior plays a key role in explaining the shifts in U.S. business cycles observed after the mid-1980s.

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Thomas A. Lubik & Pierre-Daniel G. Sarte & Felipe Schwartzman, What Inventory Behavior Tells Us About How Business Cycles Have Changed, Federal Reserve Bank of Richmond, Working Paper 14-6, 01 Mar 2014.
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Keywords: Business Cycles; Inventories; Investment Wedge; Financial Frictions
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