Chief Economist Scott Brown discusses current economic conditions.

Real GDP rose at a 6.4% annual rate in the government’s second estimate of first quarter GDP growth, the same as in the advance estimate. However, Private Domestic Final Purchases (GDP less government, net exports, and the change in inventories), a better measure of underlying domestic demand, rose at an 11.3% annual rate (vs. +10.6% in the advance estimate). Demand outpaced supply, reflected by a decrease in inventories and a wider trade deficit.

In the revised GDP report, real (that is, inflation adjusted) consumer spending rose at an 11.3% annual rate in 1Q21 (revised from +10.7%), led by a 48.6% pace in durable goods. Business fixed investment rose 10.8% (vs. 9.9%), as strength in intellectual property products and equipment offset further weakness in business structures. Residential fixed investment (homebuilding and improvements) rose 12.7% (revised from +10.8%). Net exports subtracted 1.2 percentage points from headline GDP growth, while a drop in inventories subtracted 2.8 percentage points. Note that the change in inventories contributes to the level of GDP, so the change in the change in inventories contributes to GDP growth (in this case, we went from moderate inventory growth in 4Q20 to a large inventory decline in 1Q21). Inflation-adjusted inventories fell across all major categories in the first quarter, but the decline was especially pronounced in retail autos. The semiconductor shortage has led to some softness in motor vehicle production (reported down 4.3% in the Fed’s industrial production report for April) and in new orders (down 6.2% in April). Retail auto inventories will be rebuilt, but it’s likely to take some time.

Scott Brown
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What about non-auto inventories? Manufacturing, wholesale, and non-auto retail inventories are all higher than they were before the pandemic. Inventory-to-sales ratios are not terribly out of line with pre-pandemic figures, but retail inventories are leaner. That may be part of a longer trend, reflecting increased online sales – a trend that accelerated during the pandemic. However, we should be careful in looking at broad categories, as changes in individual industries can alter the inventory-to-sales ratio. Demand for consumer goods should moderate as consumer services recover, fiscal stimulus fades, and household savings are depleted.

Some have suggested that the pandemic exposed weakness in just-in-time inventory management. The trade policy issues of the last few years have led most major manufacturers to secure supply chains, planning alternatives to possible disruptions, but the pandemic has restrained production in many areas. In addition, some of the manufacturing surveys suggest that firms may have hoarded inputs in anticipation of higher prices. That is, fear of inflation in prices of raw materials leads to actual inflation in prices of raw materials – but eventually, firms have enough and prices begin to relax. Short-term spikes in commodity prices have been a recurring phenomenon in recent decades, but never with a sustained increase in consumer price inflation.