Falling consumer confidence, increased layoff announcements, and a weak stock market will likely cause real consumption spending to fall in coming months at least to the level of falling real disposable income. Broad Inventory Corrections Can Be Ugly Those who are more optimistic about the outlook for the American economy take consolation from the notion that we are just seeing a typical inventory correction. This idea has some merit, but it fails to recognize adequately that all output slowdowns result from a need to correct inventories. It is the notion of inventories that needs to be expanded when contemplating a recession. The usual inventory correction refers to inventories of unsold goods.
Firms accelerate output growth beyond demand growth, and unsold goods pile up.
This often occurs when the Fed is tightening monetary policy in order to quell the inflation pressures that usually develop in a demand-side expansion. But firms can also accumulate excessive inventories of capital goods. If they buy too many machines or computers or, one step earlier in the production process, they tool up to produce too many machines or computers, they find that output cannot be sold at prices that yield a profit. They have usually been bought and paid for with borrowing, and the cost of financing the borrowing continues, as does paying the workers hired to work with the new capital. The degree of freedom in this case is to lay off workers while cutting prices.