Unplanned Inventories and the Decline in GDP Volatility

We study the role of inventories in explaining the decline in U.S. output volatility observed in recent years. Our analysis is motivated by two striking features in the data. First, as is commonly noted, output growth was more volatile than sales growth before 1984 but in recent years they have both become less volatile and about equally as volatile as each other. Second, the forecasting role of inventories has altered. Prior to 1984, accumulation of inventories predicted a decline in future output growth, with little predicted change in future sales. In recent years, however, the predicted adjustment of future output has diminished and instead an accumulation of inventories predicts higher growth in future sales. Using an unobserved components model to disentangle the role of inventories from that of sales in explaining the decline in output volatility, we find that inventories can explain about half of the overall decline, with reduced volatility of sales shocks explaining the other half. However, we find it is the disappearance of inventory mistakes, and not changes in inventory dynamics, that is responsible for output stabilization and has also altered the forecasting role of inventories. Furthermore, we find no evidence of a change in inventory behavior towards increased production smoothing.