Inventories and Interest Rates: A Critique of the Buffer Stock Model

Economists generally test for the effect of interest rates on inventories by including some measure of the real interest rate in a standard flexible accelerator-buffer stock model. This paper presentsseveral reasons for concluding that this approach is incorrect and demonstrates how interest rate effects can be introduced into decisionrules derived under the assumption of optimizing behavior by firms. Decision rules for finished good inventories, output, and price are estimated using monthly observations on the food and kindred product industry. The results generally conform to the predictions of the theory. Copyright 1986 by American Economic Association.