Reference no: EM131737659

Case Scenario: INVENTORY INVESTMENT DURING THE 2001 RECESSION

According to the Dating Committee of the National Bureau, the 2001 recession began in March; at the time of writing, they had not yet specified an ending date. Real GDP declined during the first three quarters of that year. During 2001, inventory investment declined from $60 billion to -$98 billion, a $158 billion drop. By comparison, total real GDP only fell from $9,244 to $9,186 billion, or $58 billion. Hence final sales rose $100 billion over that same period, or roughly 1%. That is substantially less than the average growth rate of 3% to 31 2%, but is not usually considered a recession. Hence the assumption that inventory investment is proportional to the change in final sales does not explain its sharp drop in 2001. Some other factor must have caused inventories to decline that much; if they had not, there would have been no recession in 2001. Almost all of the unusual behavior occurred in the fourth quarter. The manufacturing I/S ratio had averaged 1.43 in the first quarter of the year, and had risen slightly to 1.45 in September; it then fell to 1.39 in the fourth quarter. The wholesale trade I/S ratio was virtually unchanged throughout the year. The biggest drop occurred in the retail trade I/S ratio; it averaged 1.60 in the first quarter and was virtually unchanged at 1.59 in September, but then dropped sharply to 1.45 in October before rebounding to 1.49 by December. Almost all of the decline in inventory stocks was unexpected.

In October, manufacturing shipments rose $7 billion, while inventory stocks dropped $3 billion. In the retail sector, the changes were even more dramatic, with an $18 billion in sales largely offset by a $12 billion decline in stocks. Previously, the I/S ratio rose during the early stages of recession. The fact that it did not increase in the first three quarters of 2001 reflects the increasing importance of just-in-time and zero inventories that kept unwanted stocks from accumulating. In fact, the weakness in inventory investment started in 2000.3, shortly after final sales started to slow down; that part of the decline was consistent with the stock adjustment principle. To a certain extent, the unexpected surge in sales in 2001.4 represented zerointerest rate financing by the domestic auto companies. However, that was not the only factor leading to an increase in sales. Business almost came to a standstill for a few days after 9/11, as witnessed by the decline in new orders from $332 billion in August to $311 billion in September. However, they rebounded right back to $332 billion again in October, yet industrial production continued to decline, as most business executives were understandably concerned about weakening demand and chose not to restock those inventories that were depleted by the unexpected rise in sales. Hopefully, the events of 9/11 will never happen again. Nonetheless, some useful lessons can be learned from the behavior of inventory investment in 2001. First, over stockpiling of inventories probably will not contribute very much to business cycle fluctuations in the future. Second, when final sales weaken, the lag until inventories readjust is much shorter than it was before 1990. Third, when sales do improve, inventories are likely to decline sharply for at least one quarter before production improves.