Why Hoarding Isn’t Always a Bad Thing for GDP
Hoarders beware; the latest GDP print will put you to shame. According the Bureau of Economic Analysis, in the second quarter the US increased inventories at an annual rate of nearly $93 billion dollars. For some perspective, the US economy grew at a 4 percent annualized rate, but the inventory build-up in—called “change in private inventories” or “CIPI”—alone contributed 1.66 percent. More than 40 percent of the growth in the economy was attributable to CIPI. And that is not great news. Inventories build when the economy produces stuff it does not sell. Granted, there were some bright spots in the report—exports rose and the consumer began to spend again—but not nearly the magnitude that implied by the headline GDP growth rate. Granted, isolating the second quarter as an outlier may well be unfair. After all, the first quarter of this year witnessed inventory destocking drag it down 1.16 percent of its 2.1 percent decline. But the 4 percent growth rate was indisputably deceiving on the surface.
Distortions happen somewhat frequently. In the aftermath of the Great Recession, economic growth in the fourth quarter of 2009 was entirely due to inventory growth. CIPI contributed 4.4 percent and GDP increased only 3.9 percent. Other than increasing inventories, the economy shrank. It works in reverse as well. In the fourth quarter of 2012, the economy only grew 0.1 percent, but CIPI stripped 1.80 percent from the headline. The fundamentals of the economy was performing fine—growing nearly 2 percent, but inventories distorted away the growth.
It is obvious CIPI poses a problem to understanding what is going on in the underlying economy.—even the BEA admits it is incredibly volatile. This makes CIPI difficult to predict, and can contribute to false signals on the economy, like those mentioned above. A similar situation to the Consumer Price index (CPI), where economists look at the “core” which excludes the unstable changes in food and energy, to understand its underlying movements. To get a better look at the underlying economy, the BEA does the natural thing: drop CIPI from GDP.
The “Real Final Sales of Domestic Product”, or Final Sales, figure strips out the effect of CIPI on GDP. In many ways, this resembles more of a “core” GDP than the headline number. The number moves around in much the same way as GDP, but tends to be less wild in its movements. For example, Final Sales is estimated to be -1 percent in the first quarter and 2.3 percent for the second quarter. While not necessarily a more accurate gauge of economic activity, Final Sales provides more clarity into what the economy is actually doing.
The ease with which most economic data can be misunderstood is astounding. But it is not be too difficult to more clearly understand the health of the economy. A less volatile measure of the growth of the economy is desperately needed, and US data watchers and policymakers should place more weight on a “Core” GDP.