Recently, inventory investment has played a key role in economic growth. In 1998 changes in inventory investment accounted for 83% of GDP growth while that figure stood at less than 10% in the early 1990s.

Although the importance of inventory investment to economic growth is increasing, we have yet to understand it well. For example, many economists misinterpreted the economic situation in 1997 because of the huge inventories in the Semiconductor sector. They expected a soft landing of the economy because other economic indicators were still positive.

one economic theory considers inventories as a destabilizing factor in the economy because they are working through the inventory accelerator. In the meantime, as firms smooth over production activities in response to volatile demand, an other theory looks at inventories as a stabilizing factor in the economy. So far, no convincing theoretical or empirical evidence has been found in the economic literature. Also, there have not been enough empirical investigations to understand the effects of inventories in the Korean economy.

In order to find these effects, this paper computes the importance of inventories in terms of GDP share and GDP growth contribution. It also analyses the types of inventories, estimates the correlation with other economic indicators, and conducts a causality test.

The paper finds that changes in inventory investment account for GDP growth to a considerable extent in recession periods as well as in boom periods. At the aggregate level, the production smoothing theory is rejected, while it is accepted at many sub-industry levels. Moreover, it is found that heavy and chemical industries are more sensitive to inventory holding costs than light industries.