When investors think about gross domestic product (GDP) and its drivers, the components that often spring to mind are consumption, which accounts for the greatest share of GDP, capital expenditures, the drivers of productivity, or perhaps housing, which has a somewhat mixed reputation after the financial crisis. Yet, one of the smallest components with an outsized contribution to the swings in GDP growth is the change in private inventories; in fact, since the fourth quarter of 2007, the change in private inventories has accounted for approximately 21% of the overall variance in GDP growth.
The change in private inventories measures changes in the physical volume of net inventories owned by private businesses, and is the critical lynchpin between the demand for and the production of goods and services. Inventories tend to have a cycle of their own, often growing and contracting several times over the course of an expansion, and exerting a notable impact on economic growth; for example, inventories were responsible for over two-thirds of growth in 3Q18, while in 2Q19, they subtracted -0.9% points from the overall pace of real growth (Exhibit 1).
EXHIBIT 1: Inventory growth tends to be a swing factor for GDP growth
Change in private inventories contribution to real GDP growth