The “Bullwhip Effect” Will Frustrate The Fed

The “Bullwhip Effect” has gotten the media’s attention as of late. However, the causes, effects, and consequences to the market and monetary policy are not well discussed. In order to understand its impact on the financial ecosystem, we need a definition of the “Bullwhip Effect:”

“The bullwhip effect is a distribution channel phenomenon in which demand forecasts yield supply chain inefficiencies. It refers to increasing swings in inventory in response to shifts in consumer demand as one moves further up the supply chain.” – Wikipedia

Historically, businesses have a propensity to overestimate the strength or weakness of the consumer. When consumption is strong, businesses believe it is an indefinite state and vice versa. Therefore, small changes to the demand side of the equation tend to lead to big changes on the supply side.

“Research indicates a fluctuation in demand of 5% will get interpreted by supply chain participants as a 40% change in demand. Much like cracking a whip, a small flick of the wrist, change in demand. can cause a large motion at the end of the whip – manufacturers’ responses.” – Wikipedia

This past year, retailers over-estimated economic demand which led them to broadly over-order from their suppliers and wholesalers. Those suppliers and wholesales, in turn, over-ordered from their own suppliers. Such led to a mismatch between consumer demand and inventories. The bloated inventory levels at Walmart (WMT), Target (TGT), Gaps (GPS), and other retailers are recent examples of this “bullwhip effect,”