Analyzing Inventory Investment
INVENTORIES HAVE PLAYED A CRUCIAL ROLE in U.S. business cycles, for their perverse behavior has acted to magnify rather than dampen cyclical swings in demand. Indeed, fluctuations in inventory accumulation accounted on the average for 75 percent of the decline in real gross national product (GNP) experienced in the four recessions between 1948 and 1961. In addition, the erratic short-term behavior of inventory accumulationtypically representing half of the variation in quarterly GNP growthcreates a severe forecasting problem.
The topic is of current interest for two reasons. First, although a reduced rate of inventory accumulation contributed to the slowdown in the first half of 1970, the magnitude of the swing in inventory investment has been modest by comparison with those in similar postwar periods. Thus current developments stand in sharp contrast with experience as recent as 1966, when the annual rate of inventory accumulation reached $18.6 billion in the fourth quarter with a major reversal down to $4.4 billion by the second quarter of 1967. Do the two periods differ because the current slackening in sales was anticipated to an extent that allowed production to adjust smoothly? Or must alternative explanations be sought for the current stability of inventory investment?
Second, just as inventories have had a major influence during the contractionary phase of past cycles, they have been an important source of expansion during the initial stages of recovery—accounting for an average of 40 percent of the growth in real GNP in the first two quarters following the trough. Such historical experience has led some observers to expect a similar recovery in late 1970 or in 1971. Yet an analysis in terms of a typical "inventory cycle" is not applicable to the current situation simply because the 1969-70 economic slowdown has not been associated with a major inventory decumulation.