Inventories: The Other Stock Volatility

Can inventory accumulation offer a lasting boost to output?

The 2011 U.S. reality television show Doomsday Preppers showed an uncommon side of life, spotlighting families that prepared to survive extreme, potentially fatal scenarios. Their plans included accumulating a surplus of food, fuel, and other essentials, all of which came at a cost.

By contrast, most households and businesses carry just enough supplies to go about their routines, assuming more will always be available. The pandemic and its ensuing disruptions drew down stocks; rebuilding and holding the appropriate level of inventories has been a challenge ever since.

Private inventory growth is an important component of gross domestic product (GDP). Businesses adding to their inventories raise production levels and lift overall GDP. Uniquely among GDP components, inventories are calculated using their second derivative, or how quickly their levels change. If inventories grow at a faster pace than they did in the prior quarter, GDP increases. Conversely, if the pace of growth is slower (even if still positive), GDP decreases.

The inventory calculation is fresh on our minds after a surprise in the first quarter reading of GDP. The level of inventories was essentially flat, falling by $1.6 billion quarter over quarter, a trivial change to a stock of nearly $3 trillion. However, this was a massive decline from the prior quarter’s growth of $137 billion. That stark difference caused inventories to subtract 2.3 percentage points from the overall rate of growth, leading to the lackluster headline real growth rate of 1.1%.