Inventories and the Business Cycle: An Overview

Investment in business inventories has averaged roughly one-half of 1 percent of real GDP in the United States over the post–World War II period. Given its relatively minor role as a component of output, it might seem curious that inventory investment has traditionally drawn a great deal of interest from macroeconomists and policymakers. One reason is that although the level of inventory investment is quite small relative to GDP, fluctuations in inventory investment are not so small relative to the fluctuations in GDP. For example, changes in inventory investment are, on average, more than one-third the size of quarterly changes in real GDP over the postwar period.1 Perhaps more strikingly, table 1 shows the peak-to-trough decline in GDP and the associated decline in inventory investment during postwar recessions. The fall in inventory investment for most of these periods is generally substantial relative to the fall in real GDP, and sometimes even exceeds it. Using similar data, Blinder and Maccini (1991a, p. 291) report that “the drop in inventory investment has accounted for 87 percent of the drop in GNP during the average postwar recession in the U.S.” Movements in inventory levels over the business cycle are also closely associated with movements in output during the postwar period, with output leading inventories slightly (see figure 1).2 Furthermore, changes in inventory holdings are, on average, roughly 60 percent the size of quarterly changes in output.3 Such observations about the behavior of inventories over the business cycle, long familiar to economists, have led some to speculate that understanding the reason for inventory fluctuations may provide the key to understanding the