Int. J.

Production Economics 65 (2000) 173}178

Seasonality and the production-smoothing model

Michael F. Gorman , James I. Brannon
*
Department of Operations Research, Burlington Northern Santa Fe Railway, USA

Department of Economics, University of Wisconsin Oshkosh, Oshkosh, WI 54901, USA
Received 20 June 1996; accepted 25 January 1999

Abstract
The debate over whether "rms smooth production relative to demand continues. In this paper we "nd that results
obtained in Blinder (Quarterly Journal of Economics 101 (3) (1986) 431}453) and Blinder and Maccini (Journal of
Economic Surveys 5 (4) (1991) 293}328), indicating that "rms do not smooth production, are greatly in#uenced by the
seasonal adjustment of the Census data for US manufacturing. Using seasonally adjusted data, we "nd signi"cant
evidence of production smoothing in 10 of 14 manufacturing industries for the years 1982}1997. Further, the prevalence
of production smoothing has increased over time, which we attribute either to fundamental changes in the collection of
the data or to the advent of improved methods of inventory management.  2000 Elsevier Science B.V. All rights
reserved.
Keywords: Inventory; Backorder; Production-smoothing; Seasonal adjustment

1. Introduction
The main goal of the production-smoothing
literature has been to discern the extent to which
"rms use inventories to smooth production levels
in the face of #uctuating demand. Whether "rms
smooth or bunch production over time is not
merely an academic question; it has broad implications for the business cycle, inventory demand and
even seasonal and frictional unemployment.
Others have shown that seasonally unadjusted
data are preferable to seasonally adjusted data
when doing dynamic production studies [1}3].

* Corresponding author.
E-mail addresses: michael.gorman@bnsf.com (M.F. Gorman),
brannon@uwosh.edu (J.I. Brannon)

Nevertheless, studies have typically used seasonally

adjusted data to characterize dynamic "rm behavior [4,5]. Through a direct comparison of seasonally adjusted and unadjusted Census data, we
show that seasonally unadjusted data manifest the
production-smoothing behavior of "rms more
accurately than seasonally adjusted data.
When measuring the extent of production
smoothing, seasonally unadjusted data have two
advantages. First, seasonal #uctuations comprise
the largest source of the #uctuations in inventory,
production and shipments series, so seasonal adjustment reduces the ability to estimate the extent
of the production smoothing e!ect of inventories.
Second, seasonal #uctuations are regular, anticipated and short-lived, the type of #uctuation
over which a "rm is most likely to use inventories
to smooth production. Business cycle #uctuations

0925-5273/00/$ - see front matter  2000 Elsevier Science B.V. All rights reserved.
PII: S 0 9 2 5 - 5 2 7 3 ( 9 9 ) 0 0 0 4 9 - 3

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M.F. Gorman, J.I. Brannon / Int. J. Production Economics 65 (2000) 173}178

have a much more uncertain length and depth and

produce inventory changes that cannot be sustained inde"nitely; production adjustments follow
and inventories fail to act as a bu!er.
Our results show that the seasonal adjustment of
data alters the perceived relationship between the
production, shipments and "nished goods inventory variables and produces misleading results in
tests of production smoothing. We "nd that while
seasonally adjusted data indicates production is
more variable than shipments, indicating no production smoothing, seasonally unadjusted data
shows that production is less variable than shipments in 10 of 14 manufacturing industries. We
conclude that only seasonally unadjusted data
should be used for studies of dynamic production
behavior.

2. Literature review
Blinder [4] and Blinder and Maccini [6] "nd
little evidence to support the production-smoothing hypothesis. Using monthly, seasonally adjusted
data for durable and nondurable manufacturing
from the Census Bureau, the two studies "nd the
ratio of the variance of production to the variance
of shipments falls between 1.03 and 1.20 for the two
sectors and the covariance of shipments and change
in inventories to be positive. For two-digit SIC
industries, the ratio ranges from 0.93 to 1.38, with
17 out of 20 industries having a ratio greater than
one. A ratio of the variances of production and
shipments less than one strongly supports the production-smoothing hypothesis.
In light of the paucity of evidence supporting
production smoothing, researchers responded by
attempting to refute the very idea of production
smoothing. Production smoothing may not exist, it
has been suggested, due to the stochastic behavior
of demand, concavity of costs and the existence of
signi"cant supply shocks in manufacturing.
Researchers have also tried to "nd new ways of
testing the production-smoothing hypothesis, focusing on the properties of the data used to test the
hypothesis. For instance, there might be a positive
correlation between inventories and sales due to
the behavior of demand shocks and the develop-

ment of expectations. Blinder [4] suggests that if

a motivation for inventories is to avoid un"lled
orders, then desired inventories are a positive function of current and future expected sales. In adjustment to expectations, "rms accumulate inventories
even in the face of increased sales.
Ramey [7] argues that manufacturers face concave costs, owing to "rms' incentive to build excess
capacity and hoard labor during low production
periods. Further, Ramey suggests that concave
costs of adjustment contribute to the explanation of
production-bunching behavior. The problems of
rebalancing assembly lines when changing output
levels in capital-intensive production industries
may lead to large shifts in output rather than gradual transitions from one level to the next.
Alternatively, cost shocks through time could
cause "rms to over-produce during low-cost
periods and under-produce in high-cost periods.
Blinder [4] and West [8] note that if cost shocks
play a larger role in production decisions than
demand shocks, then "rms could optimally bunch
production. Blinder [4] doubts that cost shocks
dominate demand shocks in the macroeconomy,
but combined with the serial correlation of demand
shocks, the two e!ects could produce production
bunching.
Ray Fair [1] suggests the failure of the production smoothing model arises from the problems of
the Census data used by Blinder [4] and Blinder
and Maccini [5] and others to describe "rm behavior. Using physical unit data for various three-digit
SIC industries, Fair "nds strong support for production smoothing. Miron and Zeldes [2] as well
as Krane and Braun [9] support this story, "nding
signi"cant di!erences between Census data and
indices of production from the Federal Reserve.
However, Blanchard [10] reports evidence to the
contrary using physical data from the US automobile industry.
Ghali [3] shows seasonal adjustment a!ects
production-smoothing results. His data from the
Portland cement industry supports production
smoothing only in data that are not seasonally
adjusted; after seasonal adjustment, he obtains results similar to Blinder's. Miron and Zeldes [2] also
recognizes the importance of using seasonally
unadjusted data and "nds widely varying estimates

M.F. Gorman, J.I. Brannon / Int. J. Production Economics 65 (2000) 173}178

of production smoothing of seasonal and nonseasonal #uctuations for various two-digit SIC industries.
Ghali and Dimelis [11], using data for six highly
disaggregated industries from 1950 to 1960, "nd
signi"cant evidence of production smoothing either
using the variance bounds test or estimating a reduced form equation. They suggest that the failure
of previous models to detect production smoothing
is either due to the level of aggregation or the test
used.

3. Data
We have monthly, seasonally adjusted and unadjusted data on production, inventory, shipments
and new orders from 1959 to 1997 for 14 2-digit
SIC industries in both durable and nondurable
manufacturing. We also have the same aggregate
data for durable, nondurable and total manufacturing. All but the production series comes from data
"les supplied by the Census Bureau; production
numbers were created from the identity
P ,S #(F !F ),
(1)
R
R
R
R\
where P is the production in period t, S the shipR
R
ments in period t, and F the inventory at the end of
R
period t.
Because of their intertemporal nature, inventories cannot be properly de#ated by a simple index.
We calculate real values by considering both current and lagged price levels, as well as the age
composition of the goods held in inventory. To
de#ate nominal seasonally unadjusted data we calculated the implied de#ator of the BEA for seasonally adjusted inventories from the ratio of
nominal and real seasonally adjusted inventory
numbers [2]. As in West [8], inventory numbers
are converted from cost to market values by an
industry-speci"c factor in order to adjust for the
ratio of shipments to cost of goods sold.
Due to a change in inventory recording methods
by the Census bureau in 1982, the inventory num-

 Monthly is the greatest frequency reported; time aggregation

can obscure the inventory}production relationship.

175

bers from before and after that time are not consistent. Thus, we separate our data analysis into
pre-1982 and post-1982 results, placing more
weight on the latter simply because the revision in
the data collection appears to have signi"cantly
improved the reliability of the data.

4. Seasonally adjusted vs. unadjusted data

comparisons
Our "rst task is to demonstrate that seasonality
is indeed important in the behavior of variables
relevant to production smoothing. This is easily
achieved by examining Table 1, taken from the
1998 Current Industrial Reports, M3-1 (95). Table 1
compiles data from Appendix E (M3-1 [95]) of the
report, which details the monthly #uctuations in
inventories and shipments, the variables that sum
to production. It reports the maximum and minimum proportion of the monthly #uctuations attributable to seasonal factors for 14 2-digit SIC
variables. It shows that seasonal #uctuations are
almost always the major source of variance in every
single variable we examine, sometimes causing as
much as 98% of the total variability in inventory or
shipments. Table 1 succinctly illustrates our point
that using seasonally adjusted data when testing for
production-smoothing behavior obscures the most
important cause of demand #uctuations.
Figs. 1 and 2 also demonstrate the importance of
seasonality as a source of #uctuations. Figs. 1 and 2
show the #uctuations in durable goods shipments and inventories for the 1990s for both seasonally adjusted and unadjusted data; both show
that seasonally unadjusted data are much more
volatile.

 Until 1982, "rms were asked to report their inventories at

book values, according to whatever method they used for tax
purposes (LIFO, FIFO, and so forth). Because of this, the value
of aggregate inventories for an industry was not precise. E!ective with the 1982 Census of Manufactures, instructions for
reporting inventories changed. LIFO users were asked to report
inventories prior to the LIFO adjustment, as well as the LIFO
reserve and the LIFO value after adjustment for the reserve.
(From the Manufacturers' Shipments, Inventories, and Orders
(M3) Survey.)

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M.F. Gorman, J.I. Brannon / Int. J. Production Economics 65 (2000) 173}178

Table 1
Seasonality's e!ect on inventory and shipment time series percent of total variation attributable to seasonality from Appendix
G, Current Industrial Reports

Nondurable manufacturing
Rubber and Plastics
Petroleum
Chemicals
Paper
Textile
Tobacco
Food
Durable manufacturing
Instruments
Transportation equipment
Electronic equipment
Industrial machinery
Fabricated metals
Primary metals
Stone, clay and glass

Inventories

Shipments

Min
(%)

Max
(%)

Min
(%)

Max
(%)

41.27
29.22
33.31
33.31
55.40

83.61
42.01
81.65
68.71
90.71

89.28
86.07
93.51
86.19
96.93

54.86

65.39
52.72
79.24
61.16
84.25
78.06
94.33

37.48

95.33

26.84
30.08
20.88
35.73
29.77
34.99
47.87

51.02
72.39
78.46
78.38
68.54
51.60
71.31

73.25
52.44
82.37
74.91
55.96
74.20
85.13

91.08
87.09
93.15
98.98
92.44
89.95
90.60

Not reported.

tion smoothing. Of course, as we argued before,

there is no reason for there to be signi"cant production smoothing outside of the seasonal demand
#uctuations.
However, using seasonally unadjusted data, we
"nd abundant evidence of production smoothing.
Using the more reliable post-1982 data we "nd the
variance ratios to be below 1 in 10 of the 14 industries, as well as in aggregate non-durable, durable,
and total manufacturing. Correcting for the imprecise pre-1982 numbers and the seasonal adjustment, the data give the unmistakable impression
that production smoothing occurs to some degree
in most manufacturing industries. It is not surprising that Blinder did not detect evidence of production smoothing in his data; as we point out,
seasonal #uctuations are the source of most of the
variability in demand.
In general, seasonally unadjusted data and seasonally adjusted data provide signi"cantly di!erent
answers to the question of production smoothing.
We "nd strong support for the production-smoothing hypothesis using seasonally unadjusted data,
particularly in post-1982 data.

5. Conclusion
Consistent with Blinder [4] and Blinder and
Maccini [5], we measure the extent of production
smoothing by examining the ratio of the variance of
production to the variance of shipments for a "rm
or industry. Table 2 provides the variance ratios for
14 2-digit SIC manufacturing industries and for
total, durable, and non-durable manufacturing, calculated for both seasonally adjusted and unadjusted data. This method is intuitively appealing; a
ratio less than one indicates that output changes
less than shipments and hence inventories are being
used to smooth production.
Neither Blinder nor Blinder and Maccini "nd
much evidence of production smoothing using seasonally adjusted data; Blinder estimated a variance
ratio of 1.20 for DUR and 1.05 for NDUR; Blinder
and Maccini obtained 1.03 for both sectors with
a slightly larger data set. We "nd similar results for
seasonally adjusted data regardless of the industry,
aggregation, or time frame, with only 1 industry
(primary metals) showing any evidence of produc-

This paper supports the production-smoothing

hypothesis. While Blinder's seminal work in the
area fails to detect any evidence of production
smoothing, merely using seasonally unadjusted
data and updating the data set reverses his "nding.
Since we show that seasonal factors are the primary
source of #uctuations in output, we argue that
ignoring such factors by using seasonally adjusted
data is inappropriate.
Our results complement Ghali [3] and Dimelis
and Ghali [11], which "nd evidence of production
smoothing for a small number of highly disaggregated industries in an earlier time period. Thus,
our work suggests that production smoothing is
a somewhat robust result that is solely dependent
upon using seasonally unadjusted data.
The results have implications for any study of
dynamics; seasonal #uctuations have signi"cant
and unique impacts on intertemporal behavior and
should not be disregarded.

M.F. Gorman, J.I. Brannon / Int. J. Production Economics 65 (2000) 173}178

177

Fig. 1. Durable good shipments for seasonally adjusted and seasonally unadjusted goods.

Table 2
Var(production)/Var(shipments) for seasonally adjusted (SA)
and seasonally unadjusted (NSA) data 1958}1998
Industry

Fig. 2. SA and NSA total manufacture "nished goods inventory

1990}1998.

When there are short term, fairly predictable

changes in output demand, as we "nd in seasonal
cycles, it is only natural for "rms to respond by
using inventories as a bu!er. For less predictable
output demand #uctuations, "rms may be less apt
to respond with inventory, but may simply choose
not to "ll all orders.
A more highly disaggregated data set covering
more industries might allow the researcher to discern the extent to which inventories and un"lled
orders serve as bu!ers to output demand.

Pre-1982

Post-1982

SA

SA

NSA

NSA

Total manufacturing

1.05

1.02

1.08

0.78

Nondurable manufacturing
Rubber and plastics
Petroleum
Chemicals
Paper
Textile
Tobacco
Food

1.34
1.66
1.38
1.39
1.37
1.40
4.10
1.35

1.08
1.23
1.40
0.82
1.01
1.10
14.93
1.15

1.04
1.38
1.73
1.87
1.66
1.79
0.73
1.08

0.81
1.04
1.44
0.80
1.04
0.87
0.44
0.73

Durable manufacturing
Instruments
Transportation equipment
Electronics
Industrial and mach. equip.
Fabricated metals
Primary metals
Stone, clay and glass

1.01
2.43
1.04
1.55
1.43
1.57
0.83
1.52

1.01
1.08
0.93
1.14
1.11
1.21
0.90
0.84

1.24
1.88
1.24
2.43
3.08
1.69
0.96
1.09

0.81
0.77
0.93
0.74
0.70
1.12
0.94
0.83

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M.F. Gorman, J.I. Brannon / Int. J. Production Economics 65 (2000) 173}178

Acknowledgements
Thomas Kniesner, Benjamin Craig, John Muth
and two anonymous referees provided helpful comments on earlier drafts, and Jennifer Ribarsky
assisted with the data collection.
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