The Bureau of Economic Analysis at the Commerce Department reported this morning that United States economy grew at its fastest pace in over six years in the 4Q09. Gross domestic product (GDP) expanded at an annual rate of 5.7 percent in the fourth quarter, exceeding analysts’ expectations by some 90 basis points. Still US GDP received a lift from an inventory bounce, reflecting an acceleration in private inventory investment. The change in inventories added 3.39 percentage points to the uptick in the fourth-quarter.
From the New York Times:
The United States economy grew at its fastest pace in over six years at the end of 2009, but a sluggish job market is still souring economists on the sustainability of the recovery.
Gross domestic product expanded at an annual rate of 5.7 percent in the fourth quarter, well above analysts’ expectations. It had grown at an annualized rate of 2.2 percent in the previous quarter. Analysts had forecast annualized growth of 4.8 percent in the quarter.
The biggest lift to economic activity came because businesses ran down their stockrooms at a much slower rate than they had earlier in the year. The change in inventories added 3.39 percentage points to the fourth-quarter change.
Businesses decreased inventories by $33.5 billion in the fourth quarter, after decreases of $139.2 billion in the third quarter and $160.2 billion in the second. Slower inventory depletion is not the most promising way to guarantee growth going forward, but economists are hoping that once companies become more confident about the recovery, they may ramp up production to refill their stockroom shelves.
Here’s a short description of an Inventory Bounce from Paul Krugman:
Imagine a company that produces widgets (companies in these examples always produce widgets), normally selling 100 each month. The company tries to keep one month’s sales, 100 widgets, in inventory. But for some reason sales drop off, to 90 per month. And it takes a month before the company realizes what has happened.
At the end of that month the company, having produced 100 widgets but sold only 90, finds itself with 110 in inventory, but wants to hold only 90. To eliminate the excess inventory quickly, it might slash production to 70 for the next month, then bump production back up to 90. But unless sales increase again, that’s where it ends: production never recovers to its original level.
As go the widget-makers, so goeth the economy. When demand drops, inventories build up, then production drops sharply as businesses work off the overhang. Finally, there’s an “inventory bounce” when the overhang is gone. But the bounce doesn’t necessarily presage a true recovery. To get that, you need increased sales to final buyers.
Ed Yardeni, president of Yardeni Research and the former economist at Deutsche Bank, noted that even if there were no change in final sales of goods, the GDP figures would show a 4 percent increase simply because businesses that were emptying their warehouses a year ago are now buying enough goods to keep stockpiles steady.
“A lot of it is the arithmetic of inventories,” said Yardeni, who had been expecting a 6.5 percent jump in the GDP number. “Even if there is a very strong number for the fourth quarter, if it’s [all because of] inventories, it will raise real questions about the strength of the economy in 2010.”
Back in September in an address to the San Francisco Society of Certified Financial Analysts, San Francisco Federal Reserve President Janet Yellen had predicted the impact of inventory changes in driving US GDP and issued this important caveat:
I regret to say that I expect the recovery to be tepid. What’s more, the gradual expansion gathering steam will remain vulnerable to shocks. The financial system has improved but is not yet back to normal. It still holds hazards that could derail a fragile recovery. Even if the economy grows as I expect, things won’t feel very good for some time to come. In particular, the unemployment rate will remain elevated for a few more years, meaning hardship for millions of workers. Moreover, the slack in the economy, demonstrated by high unemployment and low utilization of industrial capacity, threatens to push inflation lower at a time when it is already below the level that, in the view of most members of the Federal Open Market Committee (FOMC) best promotes the Fed’s dual mandate for full employment and price stability. As a result, monetary policy makers will continue to face a difficult task in the years ahead.
A particularly hopeful sign is that inventories, which have been shrinking rapidly, now seem to be in better alignment with sales. That’s occurred because firms slashed production rapidly and dramatically in the face of slumping sales. Recent data suggest that this correction may be near an end and firms are now poised to step up production to match sales. In fact, I expect the biggest source of expansion in the second half of this year to come from a diminished pace of inventory liquidation by manufacturers, wholesalers, and retailers. Such a pattern is typical of business cycles. Inventory investment often is the catalyst for economic recoveries. True, the boost is usually fairly short-lived, but it can be quite important in getting things going.
Separately, the Commerce Department on Thursday reported that factory orders for manufactured goods rose 0.3 percent in December, far less than the 2 percent advance economists had expected. For all of 2009, durable goods orders plunged 20.2 percent, the largest drop since 1992.
The economy is not out of the woods by any stretch. The recovery is certainly not V-shaped but more U-shaped with the dangers of a double dip still extant.
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