The simplest macroeconomic models in which markets clear instantaneously, and expectations are rational preclude the existence of 'business cycles', that is, of serially correlated deviations of output from trend. This paper studies one of several mechanisms that can be used to make these so-called 'new-classical' models produce business cycles; the mechanism is the gradual adjustment of inventory stocks. Two macroeconomic models of inventory holdings are formulated. Both imply, first, that current output should be a decreasing function of the stock of inventories and, second, that inventories, once perturbed from equilibrium levels, should adjust only gradually. These two features are then embedded into an otherwise standard macroeconomic model in which markets clear instantaneously and expectations are rational. Two principal conclusions are reached. First, disturbances such as unanticipated changes in money will set in motion serially correlated deviations of output from trend. Second, if desired inventories are sensitive to the real interest rate, then even fully anticipated changes in money can affect real variables.
All Science Journal Classification (ASJC) codes
- Economics and Econometrics