1. Use of surveys: the case of inventories Philippe de Rougemont, Euro Area Macroeconomic Development (EAM) Directorate General Economics The views expressed are solely those of the author, and do not necessarily reflect those of the ECB Presentation to a DG-ECFIN Workshop 12/13 October 2009

2. 2 Menu Part 1 Use of surveys for conjunctural analysis Part 2 Inventories in this recession Part 3 Surveys on inventories PMI DG-ECFIN Comparison, joint use Part 4 Inventories in national accounts Link with surveys

3. 3 Part 1 Use of surveys for conjunctural analysis

4. 4 Use of surveys (1) Traditionally: –“Good”: (1) timeliness, (2) reliability, (3) frequency, (4) flexibility –“Bad”: (1) coverage, (2) not integrated, (3) subjective/qualitative But: –(a) Surveys can provide “objective” information –(b) Surveys can be seen as integrated “One respondent” –(c) Surveys provide a competitive view on economic development Ex. Puzzle: volatility of hard data on production versus surveys

5. 5 Use of surveys (2) Subjective/qualitative –Nature of the question Forecast (“What is your expected production?”) Sentiment (“Are you optimistic?”) Assessment (“How is your order book compared to normal?”) Report of an observation (“Did your past production change?”) => objective »Stocks versus flows Other issues: seasonality, working days, concepts –Response practices of respondents Modality of response: discrete rather than continuous information Band corresponding to no change The genuine “reporting” period considered Other issues (same): seasonality, working days, concepts Work of the CBI on respondents’ practices very useful –Users’ responsibility Often linear link presumed (between a survey balance and a change of an indicator)

6. 6 Use of surveys (3) Two uses of surveys: –Independent narrative Briefings / Monthly Bulletin / Annual Report –Input to “Mechanical tools” for “backcasts, nowcasts, forecasts” of GDP. See Monthly Bulletin April 2008 Importance of the horizon of estimate Bridge equations –ECB WP 276, 622, 925, 975 Factor models: substantial response on survey releases –ECB WP 894, 949, 953 Two methods: –“Accounting approach”: methodological perspective; focusing on the survey questions directly relevant (GDP nowcast  questions on past production) Frequency transformation; natural average (1,2,3,2,1) A priori lags; but respondents’ practices –“Business cycle approach”: empirical perspective; all survey questions can legitimately be used: common factor Factor models; no a priori lags

7. 7 Use of surveys (4) Avoiding misuses and communication mistakes (e.g.): –Frequency transformation: erroneous to average monthly surveys over the quarter without justification –Avoid picturing indicator’s year-on-year growth with monthly surveys –Consider the lagging/smoothing effect of stock indicators and of the relevant “reporting” period Avoid PMI/DG-ECFIN comparisons without explanations! A conceptual issue –Are “month on month” survey questions superior to “3 month on 3 month”? –Superior information content: e.g.: mid November, 6/9 of the information for Q4 growth is available –Extraction of signal problem: (1,2,3,2,1) polynomial cannot be inverted

8. 8 Use of surveys (5) In the recent recession: –The slowdown and then collapse in activity were apparent in surveys, reasonably early –However, the amplitude of the collapse was not well captured by surveys Non linear effects –Some econometric evidence –Conceptually perhaps ambiguous Smoothing effects –Some econometric evidence too –Now, an upturn (?)

9. 9 Use of surveys (6) Sources: Markit, ISM

10. 10 Use of surveys (7) Last observation in September 2009 for PMI and in July 2009 for industrial production Sources: Eurostat, Markit

11. 11 Part 2 Inventories in this recession

12. 12 PMI diffusion indexes on inventories (euro area) (1) destocking movement from summer 2008 in retail and in manufacturing inputs; (2) and from December 2008 in manufacturing finished goods; (3) destocking speed maximum in March-June 2009; (4) slowing since May-August 2009 Last observation in September 2009 Source: Markit

13. 13 Inventories in an economy (I) Input Finished goods Finished goods goods for resale Imports Consumers Producer A Producer B Retailer R goods for resale Wholesaler W Exports

14. 14 Inventories in an economy: scramble for cash (II) Deepening of the financial crisis Input Finished goods Finished goods goods for resale Imports Consumers Producer A Producer B Retailer R goods for resale Wholesaler W Exports - - - - + +++

15. 15 Inventories in an economy: cutbacks of inventories by cutting production (III) Input Finished goods Finished goods goods for resale Imports Consumers Producer A Producer B Retailer R goods for resale Wholesaler W Exports - - - - + - --

16. 16 Levels of inventories – World, US, Japan, UK, euro area Last observation in September 2009 Sources: Markit, ISM

17. 17 Destocking is a worldwide movement Worldwide destocking => Nature of the negative contributions of net trade to growth in 2008Q3, 2008Q4 and 2009Q1 for the euro area 1. Is it merely destocking by partners; or genuine weakening of their final demand? 2. What is the impact of the goods in transit? A kind of destocking at sea Net trade contribution to GDP must sum to zero worldwide (please)

18. 18 Part 3 Surveys on inventories PMI DG-ECFIN Comparison, joint use

19. 19 PMI – the question on inventories PMI respondents are being asked about: “The level of inventory (in units, not money) this month compared with the situation one month ago.” Answer around mid month => flow indicator, objectively depicting the mid month to mid month change in the volume of inventories

20. 20 PMI-based euro area inventories – but showed in levels (detrended) Note: author’s calculations cumulating demeaned PMI results and then detrending and demeaning Last observation in September 2009 Sources: Markit and author’s calculations

21. 21 PMI inventories – levels, changes and implied contributions to growth (change in change) Index and change in index – no unit Euro area – Last observation in September 2009 Sources: Markit and author’s calculations The index, change in index, and change in change in index have no unit Thus, the change in change in index needs to be rescaled to obtain a contribution of inventories to GDP growth

22. 22 Implied contributions to growth – PMI based calculations (no unit) Euro area – Last observation in September 2009 Sources: Markit and author’s calculations The implied contribution to growth has no unit, and thus, needs to be rescaled to obtain a contribution of inventories to GDP growth

23. 23 DG-ECFIN – the question on inventories Respondents are asked about: “Do you consider your current stock of finished products to be …? + too large (above normal) + adequate (normal for the season) - too small (below normal)” Stock indicator depicting an assessment For retail: “Do you consider the volume of stock you currently hold…”

24. 24 DG-ECFIN survey on inventories (assessment of stock levels): finished goods and retail Euro area – Last observation in September 2009 Source: DG-ECFIN

25. 25 Comparing DG-ECFIN survey with PMI -Stocks (DG-ECFIN) versus flows (PMI) -Assessment compared to normal (DG-ECFIN) versus objective measure (PMI) Euro area – Last observation in September 2009 Sources: Markit and author’s calculations For manufacturing, the (linear) trend is obtained by minimizing the quadratic differences over August 1997 to September 2008

26. 26 Voluntary or involuntary (de)stocking PMI and DG-ECFIN surveys can be seen as providing complementary information Their joint utilisation allows differentiating between voluntary and involuntary (de)stocking behaviours

27. 27 Stylised inventory cycle: contributions to GDP growth are of opposite sign to the deviation of inventory levels to trend Direct interpretation of DG-ECFIN survey for inventory contributions to GDP growth Given that: Y = C + Δ S We have Δ Y / Y = Δ C / Y + Δ Δ S / Y

28. 28 Part 4 Inventories in national accounts Link with surveys

29. 29 Inventories in national accounts (UK example) 15% of GDP Three “tiers” (about equal): 1.Manufacturing: input (a), output (b), work in progress (c) 2.Trade: wholesale (a), retail (b) 3.Other: construction, energy, mining, agriculture, services (yes) => Finished goods in manufacturing = 1/9 of total Survey coverage –DG-ECFIN covers 1b and 2b –PMI covers 1a, 1b and 2b

30. 30 Inventories in quarterly national accounts Inventories in Q-national accounts often compiled as residual Seasonal and working days adjustments Chain-linking volumes –No additivity of the GDP demand identity –Absence of release of the change in inventories in volume (by some statistical institutes)

31. 31 Changes in inventories and contributions of inventories to GDP growth up to 2009Q2/Q3 Eurostat and PMI Sources: Eurostat, Markit and author’s calculations Note: Changes in inventories calculated by residual; chained-link volumes

32. 32 PMI-based contributions to growth (direct calculation) and national accounts measure Last observation in September 2009 and October 2009 extrapolated Sources: Markit and author’s compilations; Eurostat

33. 33 Surveys and national accounts Simple econometrics point at a better fit using input inventories than finished goods –Interpretation? Use of total inventories not superior Too small sample Perhaps a working days adjustment difficulty

34. 34 CONCLUSIONS Surveys have the potential to provide “competitive” information on stocking behaviours by business –Good timeliness –Crucial detail of inventories –Residual nature of change in inventories in Q-national accounts Surveys have to be well understood –The importance to discriminate between inventories –The stocks versus flows issue –How to extract a contribution of inventories from PMI –How to link DG-ECFIN and PMI to extract a voluntary/involuntary pattern (or movements in inventory targets) => Wish: surveys to have both flow and stock information on inventories