Early in a recession, we expect to see inventories grow. Businesses usually don’t react instantly to the slowing pace of economic activity, and when they buy more than their customers are buying from them, their inventories get larger. And that is happening now, but not in quite the same way it has historically.
When inventories get larger, businesses respond by buying less or postponing purchases. This means manufacturers, importers, and transport companies have less work to do. This is one of the key mechanisms by which the economy slows down: high inventories lead to reductions in output.
Businesses have better information than ever and can make better decisions than in recessions of the past half century. This should limit the growth of inventories, and in fact it has. Inventory levels of most products have stayed even or fallen ever so slightly. Those are still bloated inventories, though, as inventories that have fallen by 1 percent may need to decline by 4 percent or more just to match the decline in economic activity that has occurred already.
In specific areas, inventories have grown frightfully large, just as you would find in a classic recession. You may have seen news photographs of the huge oversupply of automobiles that began to take over Detroit around August. Inventories of new houses are also at historic highs, and there are excessive inventories of toys and electronics, as consumers postpone purchases of those items. Store closings add to these inventories, as the merchandise from stores that close is shifted to other stores. The closing of the Circuit City chain is providing an excess supply of consumer electronics, and the many apparel store closings are adding to the already top-heavy inventories of some kinds of apparel.
Most inventories have been kept reasonably close to the ideal levels, though, and that is a reason for hope. The elevated inventories tell us that the economy has not hit bottom yet, but the fact that they are mostly not terribly high means that, if there isn’t further bad news, the economy might not be far from the bottom.