Discussion Paper

No. 2009-23 | April 14, 2009
Inventory Investment and the Real Interest Rate

Abstract

The relationship between inventory investment and the real interest rate has been difficult to assess empirically. Recent work has proposed a linear-quadratic inventory model with time-varying discount factor to identify the effects of real interest rate on inventory investment. The authors show that this framework does not separately identify the effects of real interest rate on inventory investment from variables that determine the expected marginal cost of production. Consequently, understanding the relationship between inventory investment and the real interest rate continues to be a challenge for macroeconomists.

JEL Classification

E11

Cite As

Sadaquat Junayed and Hashmat Khan (2009). Inventory Investment and the Real Interest Rate. Economics Discussion Papers, No 2009-23, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2009-23

Assessment



Comments and Questions


Anonymous - Referee Report 1
August 10, 2009 - 08:42

Based on the quadratic inventory investment model by Maccini et al. (2004), Junayed and Khan consider the problem of estimating the effect of changes in the real interest rate on inventory investment (which is frequently assumed to be one channel of the monetary transmission mechanism). This relationship has been much ...[more]

... analysed in different modelling and estimation contexts but has not yet been treated to satisfaction, the reason often being that researchers had to fall back on constant discount rates in order to make models estimable.

Maccini et al. model time-varying discount rates and again do not arrive at any significant correlation between the two variables. Junayed and Khan show that it is actually impossible to estimate the parameter in front of the real interest rate independently of marginal cost in Maccini et al.’s model context. Furthermore, they give an intuitive explanation, why the interest rate is invariably linked to marginal cost.

Hence, the search for a suitable econometric model to relate the interest rate to inventory investment will have to be continued.


Anonymous - Referee Report 2
August 26, 2009 - 08:34

Junayed and Khan show that the linear-quadratic inventory model with a time-varying discount factor cannot be used to identify the effect of the real interest rate on inventory investment in the way it is usually done (as in Maccini et al 2004). The authors demonstrate formally that once an implied ...[more]

... restriction of the model is imposed, the real interest rate appears at two different positions of the Euler equation. This means that the effect of the real interest rate on inventories is confounded with the effect of real output and of cost shocks. They also provide an intuition for this result.
This short paper contributes to a literature that deals with a puzzle in empirical macroeconomics. The point and its derivation are clear and correct.