FINANCIAL DETERMINANTS OF MANUFACTURING INVENTORY BEHAVIOR—A QUARTERLY STUDY BASED ON UNITED STATES ESTIMATES: 1947–61†

A LARGE PART of the fluctuation during postwar business cycles, especially during cycle contractions, has been composed of changes in manufacturers' inventories. The important role of inventory liquidation in recession has led to a number of studies in recent years, several of which have included financial variables to represent the effects of liquidity, credit availability, and interest costs on inventory behavior. Results have been either negative or inconclusive, implying that the instruments of stabilization policy that might influence inventory behavior through financial variables are unlikely to be effective. Results of these studies are dependent not only on the way in which statistical problems are handled, but also on the validity of the explicit or implicit formulation for sales expectations included in the estimating equations, on the lag structure relating previous changes in the explanatory variables to present inventory behavior, and on the specification of the financial variables examined. In particular, review of the usual proxy measures for liquidity and credit availability-the quick ratio and excess lending capacity of commercial banks-suggests that broader measures of the internal and external funds available for financing inventories might be more appropriate'than the ones used in these analyses. Also, inventory reaction to changes in the interest rate or to changes in the other financial variables is probably neither simultaneous nor likely to take place during a single, short period, though this was assumed in several of these earlier works. For these reasons, other proxies for liquidity and credit availability are considered in this study, and a number of different lags and systems of distributed lags are employed when previous changes in the explanatory variables are related to this period's inventories. Financial variables designed to represent liquidity ("internal finance"), credit availability ("external finance"), and inventory holding costs (interest rate) are included in the flexible-accelerator or capital-stock-adjustment model used in this study. "Internal finance" is defined as the sum of net retained earnings plus depreciation and depletion allowances; "external finance" includes net trade credit, long-term debt, and equity financing as well as bank loans; and interest costs are represented by rates on short-term business loans of commercial banks. Firms are assumed to adjust stocks so as partly to reduce discrepancies between actual and desired inventory levels. The desired or target levels are, in turn, a function of sales expectations and the financial variables. Since sales expectations are not always fulfilled, and since the adjustment is partial rather than complete, the process is one of gradual approximation to a continually changing target. The model was applied, in a series of estimating equations, to quarterly United States data for durable manufacturers' and all manufacturers' stocks during the 1947-61 period. Different versions of the model were tested to determine the effects of in-