By Rob Elder and John Tsoukalas of the Bank's Structural Economic Analysis Division.
As well as investing in capital, firms invest in inventories or stocks. For some businesses, investing in stocks is crucial for their profitability. Shops are better able to attract consumers if their shelves are full and they can offer a wide variety of products. Manufacturers are more likely to win contracts if their customers can trust them to cope with sudden swings in their orders by holding sufficient stocks. Nevertheless, investment in stocks is actually a very small proportion of total spending in the United Kingdom. On average between 2000 and 2005 it was just 0.4% of GDP. But it is volatile. For example, annual GDP growth slowed from 3.1% in 2004 to 1.8% in 2005. Weaker investment in stocks can account for 0.4 percentage points (or a third) of that slowdown. This article examines firms' motives for investing in inventories in order to understand the role it plays in swings in whole-economy output.