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Inventories and the Wonders of GDP Accounting

Wednesday, 22 December 2010 09:06

The news stories are coming out on the Commerce Department's release of revised data on 3rd quarter GDP and it seems that almost everyone has missed the story. The headlines of the articles are telling us that GDP growth was revised up slightly from 2.5 percent to 2.6 percent. While that may sound like at least somewhat positive news a more careful review of the data shows the opposite.

While the rate of GDP growth was revised up, the rate of final demand growth was revised down. Final demand, which is GDP excluding inventory accumulations, grew at just a 0.9 percent annual rate in the 3rd quarter, the same as its growth rate in the second quarter. The reason that GDP growth was revised upward was a more rapid reported growth in inventories.

The reported rate of inventory accumulation in the 3rd quarter was $121.4 billion (in 2005 dollars), the fastest pace ever. This added more than 1.6 percentage points to the rate of GDP growth in the quarter.

It is very unlikely that this pace of inventory growth will be sustained. Suppose that in the 4th quarter the rate of accumulation falls back to the pace of the second quarter. This would mean that inventories would subtract 1.6 percentage points from the growth rate. If final demand growth is 2.5 percent in the quarter (higher than it has been in any quarter of the recovery so far), then GDP growth would be just 0.9 percent.

In short, because the upward revision to GDP growth was based on more rapid accumulation of inventories it should not be viewed as a positive for the economy's growth prospects.

Comments (10)Add Comment
Last-In Last-Out Accounting Method Used to Pump Up GDP Growth
written by izzatzo, December 22, 2010 9:26
In continued attempts to deny a jobless recession, the Commerce Department resorted to an old accounting trick to pump up the value of GDP with fake demand based on masking excess inventory by using Last-In Last-Out (LILO) method of valuation.

LILO is considered superior to more conventional methods like FIFO, FILO and LIFO for hiding excess inventory because it causes inventory to disappear altogether.
written by JTM, December 22, 2010 9:48
Isn't adding inventory an indication of positive expectations for future demand? Can we hold on to that element of optimism?
No optimism
written by tom, December 22, 2010 10:26
Dean and others have been predicting slow growth in demand, based on their analysis of the pop of the housing bubble and the size and timing of the stimulus. The growth in inventories is not cause for optimism.
written by kharris, December 22, 2010 12:43
The measured rate of growth in personal consumption (70%-ish of GDP) is determined in large part by the pattern of growth in the prior quarter. Since the comparison between quarters is sort of average-against-average, a rise in demand into the end of one quarter means the base for the subsequent quarter starts out higher than the average for the prior quarter. (Easier to explain if I can draw a picture). In Q3, growth was stronger early in the quarter, so there is a bit of a hill to climb for PCE in Q4. However, current forecasts anticipate a pretty good rise in spending being reported for November, and the 3-month pace is grinding steadily higher. Toss it all together and it looks like the soft growth in real final sales DB notes has accelerated somewhat in Q4.
Without Stimulus to Consumer Demand We Are Stuck in 1st Gear
written by paul, December 22, 2010 12:59
Based on the resounding success of Cash-4-Clunkers in reviving the auto industry, one might assume that economists everywhere would be trying to think up ways to stimulate consumer spending again, but one would be completely wrong in that assumption. Instead, everyone is ignoring that elephant in the room in favor of tax cuts and infrastructure spending which have little or no multiplier effect.
The Economic Populist didn't miss this!
written by Robert Oak, December 22, 2010 8:36
http://www.economicpopulist.or...stimate-26 We didn't miss it and why we write up overviews on economic reports. Glad to see someone else's reads the reports instead of just writes the buzz headline. I think this revision implies some bad news actually. Real demand is below 1%!
written by Merijn Knibbe, December 23, 2010 5:34
Before the GFC of 2008, net exports started to add to demand (in fact: a decline in net imports). It seems that this trend is resumed, after the 2008-2010 turmoil.
written by Indigenous Centurion, December 24, 2010 5:59
inventories are about to disintegrate. Have you seen the draw on oil stocks? Seen the build in refinery inputs over the past 2 months? We have the economic rev-up. We only need to find employment for our brothers. John D. Rockefeller once looked at a plant manager and said, "Figure out what it is you do. Hire someone else to do it, then sit back relax and figure out how to make more money for Standard Oil."

Do we need to hire up the unemployed? Teach them to do what we are now wasting time at? Is it time for us to saddle up and ride out?

We got us a posse
written by Philip Pilkington, December 28, 2010 9:24
Again, I'll ask - is this tied into what I was emailing you about?

Is this not simply a build up in housing inventories, but a build up in inventories generally?

Is what we're seeing - to put it in old skool terms - a 'crisis of overproduction'? Are we seeing producers believe their own lies - and not just in housing?

This, in my opinion, would be an extremely important development in the contemporary economy - something which certain economists have been warning for years. Namely: the wage-price gap... and the resulting demand frustration, if I can put it as such...
Real wages=insufficient demand
written by Mike B), January 03, 2011 6:04
Inventories build up while workers remain unemployed because they produce too much. Insufficient demand hits the fan.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.