Inventory Recession Ahead

Business sales have grown faster than business inventories during the current expansion. The resulting decline in the inventory-sales ratio has been viewed as evidence that inventories are now under tighter control than during previous expansions. It is also widely believed that this improved inventory control has reduced the chances that cyclical swings in economic activity will be exacerbated by severe fluctuations in inventory investment. This article shows that a lower risk of a severe inventory recession does not necessarily follow from improved inventory control. A standard model of inventory investment is used to identify two dimensions of better inventory control: lower inventory-to-sales ratios, and faster adjustments to desired stocks of inventories. Empirical support for the hypothesis of improved inventory control is provided by comparing values of these inventory control parameters, estimated for the post-1975 period, to values estimated for an earlier period. The implications of tighter inventory control for the volatility of inventory investment are then explored. A simulation Stephen L. Able is a business economist and Dan M. Bechter is an assistant vice president and economist, with the Federal Reserve Bank of Kansas City. forecast is used to show that, because the two dimensions of tighter inventory control work in opposite directions as far as the size of inventory adjustments are concerned, better inventory management does not necessarily reduce the chances of a sharp inventory recession in the future.