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A Rational Expectations Equilibrium Model of the Cyclical Behavior of Inventories and Employment

Working Paper 148 | Published May 1, 1980

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Author

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Martin Eichenbaum

A Rational Expectations Equilibrium Model of the Cyclical Behavior of Inventories and Employment

Abstract

A critical roadblock to modelling inventories of finished goods has been the claim that production and inventory decisions of a perfectly competitive firm are determined independently of each other. A basic goal of this study is to specify fundamental preferences of economic agents, technologies, constraints and market structures that are, in a rough way, capable of generating patterns of serial correlation and cross correlation between inventories and employment of factors of production that are consistent with those observed in the data. The claim is made that the time series for inventories, output and employment can be interpreted as emerging from a well specified dynamic, stochastic competitive equilibrium in which economic agents are assumed to form rational expectations about variables not included in their information sets. Inventories and employment will not be related in a direct way if and only if the price elasticity of demand for output is equal to infinity.


A 17 page handout accompanies this paper, and is included in the file list below.