May 26, 2022
When the economy is slowing down, firms will accumulate unwanted inventories. Those inventories still show up in GDP, but they are unsold. Hence, GDP will be biased upwards. Similarly, in good times businesses will reduce inventory levels to satisfy demand. In this case, GDP growth will be understated.
To get a sense of the underlying pace of sales, economists will look at final sales which is GDP less the change in business inventories. Final sales, which is GDP excluding the change in business inventories, fell 0.4% in the first quarter after having risen 1.5% in the fourth quarter, Given a GDP decline of 1.5% and a 0.4% drop in final sales, inventories subtracted 1.1% from GDP growth in that quarter. Inventories rose sharply in the first quarter, but at a slower pace than in the previous quarter. Thus, inventories subtracted from GDP growth in the first quarter. But just remember that inventories began to shrink rapidly once the economy began to recover. Demand was robust and businesses could not keep pace. As a result, firms were forced to dip into inventories to satisfy as much of that robust demand as they could. Now they are beginning to replenish those depleted inventory levels, but they happened to do so at a slower pace in the first quarter than they did in the fourth.