INVENTORIES IN THE KEYNESIAN MACRO MODEL

Abstract

An otherwise conventional Keynesian macro model is modified to include inventories of final goods by (1) drawing a distinction between production and final sales, and (2) allowing for a negative effect of the level of inventories on production. Two models are presented: one in which the labor market clears and one in which it does not. Both models are stable only if the negative effect of inventories on production is ‘large enough’. Both models also imply that real wages move procyclically - in direct contrast to the usual implication of Keynesian models. Detailed analysis of the market-clearing model shows that there should be negative correlation between the levels of inventories and output, and between changes in inventories and changes in output, over the business cycle. However, inventory change should be positively correlated with the level of output.

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