A blog from BEA Director Vipin Arora
The first time a friend handed me a Rubik’s Cube I thought it would be easy to solve. I was wrong. BEA’s estimates of businesses’ inventories sometimes remind me of that experience. They seem relatively simple at first, but they turn out to be more complicated than expected. The good news is that, just like we can learn to solve a Rubik’s Cube with a few rules of thumb, we can understand BEA’s estimates of the change in private inventories with some basic principles.
The first is that our estimates of the change in private inventories, affectionately referred to as “CIPI,” measure the value of the change in the stock of inventories held by private businesses. Sometimes people are surprised that the estimates measure the change in the value of the stockpiles, not the entire stockpiles themselves. Why? Because in economic accounting we record production when it occurs—and CIPI is the way we bridge between final sales and production for any given period.
For example, consider a quarter where domestic production exceeds final sales. How do we account for the excess production that is not sold? Because companies will put these goods into inventory, the excess production will be reflected as a positive change in private inventories in the current quarter. When those goods are taken out of inventory in a future quarter and sold, we will account for it with both a negative change in private inventories and an offsetting positive value for the sale of the items in that future quarter. In this way, our CIPI estimate will ensure that all production taking place in a given period is accounted for in that period.
The second principle is that production should be valued at the price prevailing when it occurs. This sounds simple enough, but it has an interesting implication: a good which is withdrawn from inventory must be valued at the price prevailing when it is withdrawn (not when it entered inventory). For example, oil that enters inventory in the current period and oil that was produced a year earlier but leaves inventory in the current period are both valued at the same price in the current period. This ensures that holding gains or losses due to price movements do not affect our measure of production in the current period.
With this understanding in our back pocket, we can better use BEA’s CIPI estimates to study key economic issues, such as the timing, duration, and magnitude of business cycles. Unanticipated buildups in inventories may signal future cutbacks in production, while unanticipated shortages in inventories may signal future pickups in production. The stock estimates also are used to create inventory-to-sales ratios that can be used to assess the likelihood that businesses will add to or reduce inventories in response to changes in demand. Just like the layer-by-layer method can help us to solve a Rubik’s Cube, these two principles can help us to understand BEA’s estimates of the change in private inventories.