Taking stock of the inventory contribution to US growth

Tom Traill - 20 December 2018

When inventory change makes an outsized positive contribution to quarterly GDP change, it is common to hear the charge that economic growth is exaggerated and will surely be reversed. This view neglects the close offsetting relationship between inventories and net exports, particularly in nominal terms. After netting off the movement in external trade, the resulting GDP growth impact is rarely more than 20 basis points in either direction. This net component is significantly influenced by the relative strength of the US Dollar. 

At a time of heightened concerns over the momentum of the US economy, the large positive inventory contribution to GDP in Q3 is viewed in some quarters as proof of economic vulnerability. It has been spun as a shortfall in consumer demand that has resulted in unsold stock and is thus a harbinger of weaker growth in succeeding quarters. In fact, when inventory change makes a large positive contribution it is invariably offset in large measure by an opposite movement in net exports (figure 1).

Typically, a surge in imports is often associated with a bulge in inventory. As goods imports are digested in US domestic supply chains, so inventory levels normalize. A sudden jump in the inventory contribution, offset by a worsening of net trade, has no special significance.  It does not signify a change in the potential path of GDP. Most of the time the net contribution of inventory change and net exports of goods and services to GDP growth is minimal – particularly in nominal terms. In figure 2, its growth contribution is seldom larger than 20 basis points, up or down. Figure 3 demonstrates a close connection between the relative strength of the US Dollar and the net growth contribution of inventory change and net exports combined. 

Occasionally there is a serious supply chain disruption, as in 2008-09, which impacts exports and imports in a similar way. However, if domestic producers run down their inventories of imported energy, raw materials and semi-manufactures, this leads to a plunge in the net GDP contribution. When the disruption ends, the inventory effect reverses powerfully. This is not to argue that there will not be a US slowdown, but rather to downplay the role of inventories in signalling one. 

It is likely that the increase in inventories is, at least in part, a response to the spectre of increased tariffs and deteriorating international trade relationships. A lurch to protectionism, potentially coupled with a slowdown in the Chinese economy, would be a genuine cause for concern for US growth prospects. Better to focus on the fundamentals than on inventory dynamics. 

Figure 1

Data source: Bureau of Economic Analysis 

Figure 2

Data source: Bureau of Economic Analysis

Figure 3

Data source: Bureau of Economic Analysis and Bank for International Settlements

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