Input and Output Inventories in General Equilibrium

We build and estimate a two-sector (goods and services) dynamic general equilibrium model with two types of inventories: finished goods (output) inventories yield utility services while materials (input) inventories facilitate the production of goods. The model, which contains neutral and inventory-specific technology shocks and preference shocks, is estimated by Bayesian methods. The estimated model replicates the volatility and cyclicality of inventory investment and inventory-target ratios. When estimated over subperiods, the results suggest that changes in the volatility of inventory shocks, or in structural parameters associated with inventories, play a minor role in the reduction of the volatility of output.