David Altig says he isn't too worried about inventory accumulation in the fourth quarter of last year translating into slower growth in the first part of this year (I added some general comments on the recovery at the end):
Reading the bump in inventories, by David Altig: Yesterday's wholesale trade report, with its positive surprise in December inventory accumulation, has estimates of fourth quarter gross domestic product (GDP) on the rise again. For the advance GDP release, the U.S. Bureau of Economic Analysis assumed that the book value of merchant wholesale inventories rose by $17 billion (at a seasonally adjusted annual rate, or SAAR) in December. The wholesale trade report suggests the book value instead may have risen by $56 billion SAAR. Our own calculations suggest fourth quarter GDP may be revised up from 2.8 percent to around 3.1 percent. A piece of that revision comes from positive sales activity, which would appear to be an unambiguous plus.
The inventory piece is trickier. Forecasters have a tendency—because the statistics have a tendency—to take a larger-than-expected inventory buildup in one quarter out of growth estimates for the next quarter. The implication in present tense is, of course, that 2012 may start out on the slow side as the fourth quarter inventory swell is run off.
That's not how we see it. Our current read is that it is better to think of the fourth quarter inventory buildup as a payback from a decumulation in the third quarter. Here's a look at overall inventory changes over the recent past, broken down into their various industrial components:
If you look hard, you will see that, though the fourth quarter inventory rise was broad-based, the third to fourth quarter change in wholesale inventories was particularly notable. In fact, the wholesale inventory picture in the back half of 2011 was dominated by a fairly large decumulation of nondurable goods inventories in the third quarter, a decline that was reversed in the last three months of the year:
In the background of those details are some pretty nonthreatening-looking inventory-sales ratios:
So, consider two stories that might frame thinking about the role of inventories in GDP growth in the first quarter or first half of this year. One story is inventory-inflated growth in the fourth quarter of 2011, to be followed by payback in the form of a drag on production in the first quarter (or so) of 2012. Another story is that the drag actually emerged in the third quarter of last year, providing a little extra juice in the fourth quarter, with no particular consequences for the current-year growth trajectory.
Right now, it looks to us like the latter story might be the right one. Of course, that doesn't mean there aren't significant risks to the outlook for domestic production, and hence inventories. For instance, although today's report on international trade in December was relatively benign in terms of fourth quarter GDP revisions, it did show a substantial further weakening in exports to the euro zone. Weaker demand from Europe will weigh on U.S. export growth. The big unknown is how weak that demand will get.
For me the big uncertainties right now are the pace of the recovery (will it remain plodding and take years or will we see an accelerattion in activity?), how much trouble we'll encounter along the way -- it's unlikely the return to full employment will come without setbacks of some sort -- whether the setbacks will be temporary blips or longer lived problems, and how policymakers react when the inevitable trouble hits.
Policymakers will have a lot to do with how those uncertainites play out. Monetary and fiscal authorities could push a faster recovery with the appropriate policies, but while the Fed seems more inclined in this direction than fiscal authorities, I don't expect anything substantial from either. More likely is that policies will be reversed before the economy is ready for it. If monetary and fiscal authorities withdraw support for the economy too soon through austerity measures designed to balance the budget and interest rate increases out of fear of inflation, the recovery will be delayed. In addition, there will be a tendency for policymakers to minimize any trouble we encounter and continue with the assumption that greener pastures are just around the corner. This avoids difficult policy decisions, but misplaced optimism of the type we've seen throughout the crisis puts policymakers behind the curve when we encounter difficulties that are persistant rather than blips, and the delayed policy response hampers our recovery efforts. The risks of too much policy and too little are not symmetric. If policymakers make a mistake, it ought to be in the direction of too much support for the economy for too long rather than too little support that ends early. The reality is that policy support has been too little all along, and that's unlikely to change, but that doesn't mean it also has to be reversed too soon as well.