THE LINEAR-QUADRATIC INVENTORY MODEL AS A MICRO FOUNDATION FOR KEYNESIAN THEORIES OF THE BUSINESS-CYCLE

Aggregate inventory investment is invariably procyclical. This suggest s that inventories play a destabilizing role in the economy as predict ed by early Keynesian models of the business cycle. However, this beha vior is believed to be inconsistent with the most prominent micro theo ry of inventories - the linear quadratic model. This is not the case. The linear quadratic model, when placed in a simple macro framework, c an account for the procyclical behavior of inventory investment, even when the only shocks are independent demand shocks, inventory targets are independent of sales and individual firms adjust inventories slowl y towards their target levels. (C) 1998 Elsevier Science B.V. All righ ts reserved.