What is wrong with having more than half of our growth coming from inventories?
First of all, in the medium term we are probably going to see inventories decrease more, not less, on average. Current inventory levels, as measured by the sales-to-inventory ratio, are too high relative to their long-term trend. (See Chart 2.) True, inventories plummeted through 2009, but that was just a correction to the excess stockpiles accumulated during 2008. Taking the recent trend of the sales-to-inventory ratio as benchmark, we should now be closer to 1.2 than to the 1.28 where we actually are. In the near term, therefore, and on average, we should expect net declines in inventories.
Secondly, (optimistic) observers may have claimed that the positive contribution of the change in inventories is a sign that businesses anticipate an increase in demand. In fact, the present behavior of inventories is just a reflection of the economic past: businesses are increasing stockpiles, or at least reducing them more slowly, because consumption expenditures have picked up over the past six months. In other words, businesses are best characterized as backward-looking creatures. There is a strong correlation between current changes in private inventories and the past increase in personal consumption expenditures (PCE). (See Chart 3.) In fact, using quarterly data, the correlation coefficient is around 0.7. The correlation between changes in inventories and future PCE growth, on the other hand, is only 0.4. Saying that increases in inventories forebode stronger demand in the near future is almost wishful thinking.