PROTECTING SMALL BUSINESS, PROMOTING ENTREPRENEURSHIP

GDP Growth and the Impact of Private Inventories

By at 28 September, 2018, 8:54 am

 

by Raymond J. Keating

In its third estimate of second quarter real GDP, the U.S. Bureau of Economic Analysis (BEA) served up no significant changes from its previous estimate. Real GDP growth during the second quarter registered 4.2 percent. That rate of growth was the fastest since the third quarter of 2014.

It’s worth noting that in terms of contributions to the real GDP growth rate, the change in private inventories actually contributed -1.17 percentage points to the overall GDP growth rate. That’s significant. So, what does it mean?

Changes in private inventories tend to have temporary effects on GDP and can occur for a variety of reasons. For example, a jump in inventories can result from a drop in consumer demand, which would be a longer term negative as factories subsequently slow to work off those inventories. Or, an inventory increase can simply be a replenishment of recently depleted inventories. Again, this would be more of a temporary phenomenon.

As for a large decline in inventories, that could result from strong consumer demand, which would feed into the idea that the economy is growing strongly, and inventories will need replenishment. Or, a decline in inventories could simply reflect a momentary depletion in need of a temporary replenishment. In a poor economy, a decline in inventories might not be significantly replenished if businesses don’t have expectations for strong sales going forward.

In the case of the second quarter’s decline in inventories, it’s reasonable, given other positive signals on the economy, that third quarter (and perhaps the fourth quarter as well) real GDP growth rate will be positively impacted by inventory replenishment, as well as due to added production resulting from recent strong growth in investment and solid consumer confidence.

Over the long haul, changes in private inventories tend to be a wash in terms of GDP growth. Since the end of World War II, real changes in private inventories has contributed an average of 0.07 percentage points to the average growth rate of 3.2 percent. But in the short term, inventory changes can have a significant impact of the economy’s stated rate of growth. And despite real GDP growing at a strong 4.2 percent in the second quarter, the change in inventories actually significantly reduced that quarter’s growth rate. We should expect to see that reversed, with inventories making a positive contribution to growth, in the coming quarter’s or quarters’ data.

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Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

Keating’s latest book published by SBE Council is titled Unleashing Small Business Through IP:  The Role of Intellectual Property in Driving Entrepreneurship, Innovation and Investment and it is available free on SBE Council’s website here.

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