Wednesday, May 13, 2009

Inventory Correction Far From Over

Because inventories made a large negative contribution to U.S. first quarter GDP, it is widely assumed that businesses will need to rebuild them, something which will supposedly create a recovery later in the year. The problem with this theory is that while inventories have been reduced, sales have fallen even more, causing the inventory to sales ratio to rise far above previous levels.

Because the contribution to GDP from inventiories reduction is counted in terms of the change the latest quarter compared to the change in the previous quarter ( the contribution is so to speak the second derivative (the change of the change), and not the first derivative(the actual change)) it is unlikely that inventories will continue to lower GDP as much as in the first quarter, and it is even possible that it will make a positive net contribution later this year. But given how high the current level of inventories is, further inventory reductions should be expected, meaning that there will not be a particularly large contribution to growth from inventories even later this year.


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