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INVENTORY MISMATCHES CONTINUE TO BE WIDESPREAD
September 27, 2022
By Nathan Jefferson
Even as the worst of the COVID-19 disruptions have eased in recent months, the
pandemic’s impact has continued to ripple throughout the global economy.
Second-order effects1Second-order effects refers to outcomes that come about not
due to the original action, but the consequences of the original action. can
still be found all over, and navigating these changes can be just as tricky as
maneuvering through the initial shocks.
One example can be found in inventories. The St. Louis Fed’s Quarterly Survey of
Regional Businesses found that a majority of respondents across the logistics
(auto sales plus transport), manufacturing and retail sectors were holding
inventories either above or below desired levels in the second quarter. This
aligns with wider economic reporting on the same phenomenon. The industries
vary, but the overall conclusions are the same: Many firms are holding too much
or too little stuff.
Among Eighth District Firms, Are Inventories at Desired Levels?
SOURCE: Federal Reserve Bank of St. Louis Quarterly Survey of Regional
Businesses (2022:Q2).
HOW THE MISALIGNMENT HAPPENED
How did this mismatch in inventories happen, and why is it persisting nationally
even as the global economy continues to grow?
To understand better, we need to go back to spring 2020. Widespread lockdowns
disrupted supply chains and—just as important—led to new spending patterns.
Households spent more on durable goods and less on services. At the same time,
U.S. manufacturers and retailers struggled to produce and import key inputs and
finished goods. Firms that used just-in-time (JIT) inventory management faced
particular difficulties; JIT calls for firms to hold only the goods they need,
when they need them. This increases efficiency but relies on a steady flow of
goods. If the flows are disrupted, firms find themselves without needed
inventory.
In response to these disruptions, firms ordered aggressively to meet demand. As
shown in the figure below, wholesale inventories have posted strong growth since
July 2020, and the rate of monthly growth has increased over this time as
backlogs eased. Monthly growth peaked at 2.8% in February 2022—the highest on
record. These inventory increases are especially pronounced when focusing on
sectors less hindered by supply shortages. Retail inventories excluding autos
saw even stronger monthly growth over this period, peaking at 3.6% growth in
2021.
Wholesale and Retail Inventories Have Rebounded Since July 2020
Despite all this, consumer demand remained so strong that retailers’
inventory-to-sales ratios fell below historical averages. (See the figure
below.) This ratio can be thought of as the number of months of inventory that a
retailer has available. In mid-2021, retailers had only 1.1 months’ worth of
inventory on hand—the lowest on record. While the ratio has risen to 1.2 as of
July 2022, it is still well below the typical pre-pandemic range of 1.3 to 1.5.
In contrast, the inventory-to-sales ratio for manufacturers is above the
pre-pandemic trend. Like retailers, manufacturers have added record amounts of
inventory during the pandemic. The Institute for Supply Management (ISM)
Inventories Index reported strong inventory growth in recent months, with the
index reaching 52.8% in July 2022—the highest level since July 1984. For
manufacturers, the need to increase inventories to withstand supply chain
disruptions is even more pronounced than for retailers; shortages in any key
input can result in significant production delays. As a result, the pandemic has
spurred firms to stockpile inputs in an attempt to avoid the risks of
just-in-time delivery.
Manufacturers Have Stockpiled Inventories to Withstand Disruptions
WHAT COMES NEXT?
Higher inflation and new shifts in consumer behavior have created new
uncertainty for retailers and manufacturers. Consumer spending on services has
continued to rise, and inflation has softened demand for some durable goods that
saw growth during the pandemic. Because of this, some large retailers have found
themselves with unwanted inventories ordered long ago. These retailers face a
choice between storing excess inventory or offering discounts to move these
goods—both of which come with downsides.
For manufacturers, there is concern that the shifting economic environment might
lead to unwanted high inventories. While carrying more inventory helps soften
the impact of supply disruptions, high inventories bring costs of their own.
Storing extra inventories can be costly—firms need warehouse space, as well as
the transport and labor to move their excess goods. Once stored, firms may need
to lower prices in the future to offload excess goods.
The ISM New Orders Index contracted in July for a second month in a row. Still,
long lead times for key products remain an issue, meaning that manufacturers,
like retailers, remain in the uneasy position of worrying about inventories both
above and below desired levels.
Notes
1. Second-order effects refers to outcomes that come about not due to the
original action, but the consequences of the original action.
About the Author
Nathan Jefferson
Nathan Jefferson is an associate economist at the Federal Reserve Bank of St.
Louis. Learn more about the author.
Nathan Jefferson
Nathan Jefferson is an associate economist at the Federal Reserve Bank of St.
Louis. Learn more about the author.
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