Friday, January 29, 2010


Help Me Out With the "Inventory Bounce" Cynicism

I am as skeptical of GDP numbers as the next guy. But I don't quite get this commentary by Krugman:
As expected, a big GDP number (pdf), signifying nothing much. It’s an inventory blip: topline growth at 5.7 percent, but only 2.2 of that is final demand.
Don't get me wrong, I understand the superficial plausibility of distinguishing between changes in final demand versus "mere" changes in inventory. But when we push the analysis one step deeper, I can't come up with the same conclusion that Krugman reaches. (It's not just him, by the way, lot's of people talk like this.)

If I'm not mistaken, the procedure (roughly speaking) goes like this: The BEA measures how much money people spend on finished goods and services. But that figure isn't necessarily how much businesses produced during the quarter, because some of those sales could have been handled through falling inventories.

So for example, if final sales were $1 trillion, but inventories declined by $100 billion, then they would subtract it and say that GDP was actually only $900 billion. In other words, only $900 billion in stuff was actually produced, since the other $100 billion in sales came from drawing down inventories (which were produced in earlier periods).

OK, so now for today's announcement of the 4th quarter GDP figures, Krugman is saying that the 5.7% official figure is misleading, because if you strip out inventories, then "final demand" only grew 2.2%. This strikes me as backwards.

If you break down the numbers, inventories still fell in the 4th quarter, they just didn't fall as sharply as in the 3rd quarter:
Business inventories fell only $33.5 billion in fourth quarter after dropping $139.2 billion in the July-September period. The change in inventories alone added 3.39 percentage points to GDP in the last quarter. This was the biggest percentage contribution since the fourth quarter of 1987.
Am I making sense here? I can understand if inventories rose by a bunch, and then Krugman wanted to say, "Aww, that's just firms replenishing their depleted inventories--this isn't really a spike in final demand by consumers."

Can anybody clarify this? I am hesitant to say not only Krugman, but many other commentators, on this point are getting things backwards, especially since I'm no expert on GDP accounting. I am thinking I'm doing something wrong, because in my version I don't see where the 2.2% figure is coming from, when you "strip out inventories," if they only fell by $33.5 billion.

I wasn't aware that GDP received this adjustment.

Inventory at what level? My company's sales are my customer's inventory. And so on, and so on, until the final product reaches the consumer.

Reading it over a few times (thanks for making my brain hurt), it does appear that you are correct Bob. I'm more confused that Krugman is not using the opportunity to praise the effectivity of the stimulus.
The real issue is whether this is an inventory adjustment, which occurs when companies draw down too far on their inventories and must now align those inventories with their sales. Or, whether what we are seeing are companies rebuilding inventories because they anticipate higher sales.

During a recession a company may deliberately run down inventories to control costs. As the economy recovers, those stocks must be replenished. The crucial question is this: are companies rebuilding stock in anticipation of recovery and higher sales, or are they simply correcting an overshoot to the down side.

Krugman think it is the latter. Rosie agrees with him.

I've looked at the BEA announcement, and there is nothing in it about inventories. However, I agree with you that a fall in inventories is a negative, since production going into inventory was a previous positive.

More importantly, we need to know how much of this growth was down to increased government spending, and subtract that out of the GDP figures to know what the private sector is doing, because that is the true economy. Which, of course, makes these GDP numbers totally meaningless.

Another thought. Monetary inflation adds to the government contribution to GDP before it is deducted from the private sector in the form of price inflation. That was probably worth most of the growth in GDP for the quarter.
Charley wrote:

The crucial question is this: are companies rebuilding stock in anticipation of recovery and higher sales, or are they simply correcting an overshoot to the down side.

Right, that would make sense to me, if companies were rebuilding stock. But I think all that happened is that the rate of decline, fell.

So it seems to me that Krugman is grabbing a point to reinforce his cynicism that doesn't quite fit. But as I said, I am willing to be corrected on this.
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