Structural Instability and the Production-Smoothing Model of Inventories

The production-smoothing model of inventories implies that inventories, labor inputs, sales, and factor input prices are cointegrated if sales and factor prices are I(1) with one cointegrating vector for each state variable held. These propositions are tested in six nondurable-goods industries. All industries provide evidence of cointegration. Fewer quasi-fixed factors are found than previous research often assumed. Estimates of cointegrating vectors provide implausible parameter estimates. Rank stability tests, with fixed or seqentially chosen breakpoints, indicate that the cointegrating matrix has unstable rank. Parameter estimates of cointegrating vectors do not provide much support for the production-smoothing model of inventories.