The Ides of Inflation

Et tu, Corporate Profits?

“Aye, [price increases have] come, but they are not gone.”

The Soothsayer, to Julius Caesar¹

A couple years back an astute reader of Macrosight asked in the comments about the role that corporate profits play in driving the rate of inflation.² This was a great question and with inflation remaining stubborn, it is one that is still on the minds of many. For example, Jon Stewart, interviewing economist and former Treasury Secretary, Lawrence Summers, took particular umbrage at the notion that corporate profits are not behind the rise in the prices of goods and services. Others have discussed the link between corporate profits and inflation under the moniker “Greedflation.”³

On the heels of last week’s post on food prices, it is natural to consider this question. And since corporate profits are also an important component of GDP-accounting, the topic also provides a chance to learn yet another detail about our macroeconomy. 

Corporate Profits and National Income

As measured by the Bureau of Economic Analysis (BEA), corporate profits represent the income earned (revenue earned minus costs) from current production by U.S. corporations.⁴

With respect to GDP-accounting, corporate profits are tallied as part of a measure known as “Total Income.” Total income represents just that, all possible income streams earned by everyone in our economy, whether that be corporations, private businesses, those working for themselves, or those employed by those entities. Total Income provides an alternative method to “gross domestic product” (GDP) to measuring the size of the macroeconomy. While the computation of GDP focuses on the production and purchase of goods and services, Total Income focuses on the payment flows related to that production and purchase. At the “end of the day” the two measures should be equal.⁵

Figure 1 displays the categories that make-up Total Income, with the percentages shown representing the average share of each category from 2000 through the third quarter of 2023 (the latest data available for these categories).   

In what may come as a surprise to many, the largest component of National Income is “wages and salaries” (this category includes employee contributions to pension and insurance funds, and government social insurance). However, if one recalls that consumption expenditure makes up about two-thirds of GDP in any given year, it makes sense that a dominant share of National Income would be the wages and salaries of those doing the consuming. 63 percent equates to about $14 trillion of $23 trillion in Total Income reported for the third quarter of 2023.

The second-largest component of National Income is corporate profits (14 percent), equating to about $3.3 trillion in the third quarter of 2023.

Of course, what is of direct interest with respect to corporate profits is not the relative share to Total Income, but what role this category may play in explaining the rate of inflation over the past few years. To answer that, let’s first look at the growth of corporate profits over time (along with the growth of wages and salaries).

The Growth of Profits

Figure 2 displays the growth rates of the corporate profits and wages and salaries categories from 2000 through the third quarter of 2023. The top panel shows that entire span of time while the bottom panel focuses on 2020 and after. For reference, the figures are annotated to also include the growth rates of real GDP and the rate of inflation (as measured by the GDP deflator), though the figures do not display those series.⁶

Clearly, since 2000 the average rate of increase of corporate profits is larger than the rate for wages and salaries. Profits have averaged a quarterly increase of 8.9 percent since the beginning of 2020; wages and salaries have averaged 5.8 percent. Some other things to notice:

• Compared to the 2000 to 2019 average, the rates of growth for both categories are higher over the 2020 to 2023Q3 period.

• The growth rate of corporate profits is much more volatile than wages and salaries (the standard deviation⁷ of the former from 2000 to 2023Q3 is 26.7 percent, while the standard deviation of the latter is 5.1 percent).

• While corporate profits have been volatile since 2020, that does not appear to be unusual when looking back to 2000.

• Profits are much more prone to going negative, while wages and salaries do so infrequently (in only eight quarters out of 95 over this time frame has the wages and salaries category had a negative quarterly growth rate). Over the entire 2000 to 2023q3 period, when the quarterly growth rate is negative, corporate profits decrease at an average rate of 14.5 percent, while wages decrease at an average of 5.5 percent (see footnote 7).

• But, when growth is positive, corporate profits rise at much faster rate than wages and salaries and do so more often. Over the entire 2000 to 2023q3 period, when the quarterly growth rate is positive, corporate profits increase at an average rate of 18 percent, while wages increase at an average of 5.1 percent (see footnote 7).

So, what do those observations have to do with inflation? Well, there is not much direct inference to draw from those figures in that regard. But, we at least have an idea of what has been happening with corporate profits over time. To address the “Greedflation” question, we can compute the correlation of changes in corporate profits with changes in inflation over time.

An Inflation-Corporate-Profits connection?

Table 1 displays the correlation coefficients for the link between the rate of inflation and corporate profits, the rate of inflation and wages and salaries, and the rates of both and real GDP growth—computed over different time periods listed at head of each column.

First, with respect to GDP growth, both corporate profits and wages and salaries are “pro-cyclical”—meaning both categories are positively correlated with real GDP growth over time.⁸ The correlations, too, are relatively large for most time periods, with wages and salaries showing the strongest correlations with GDP growth.

Second, with respect to the rate of inflation, the correlation with corporate profits is more varied, if not pretty weak. From 2000 to 2019 the correlation is essentially zero, which matches the longer historical picture (the last two columns).⁹ However, since 2020, the association between the two variables is much higher at 0.33.

Wages and salaries are, as it turns out, more positively correlated with the rate of inflation than corporate profits. And that appears to be case over the long run as well as in our more recent experience.

Interpretation

The above analysis does not disprove the idea of Greedflation. If one did a more disaggregated analysis, one might find better evidence in certain sectors (food, for example) or for certain very large corporations. But, at least from the analysis of the aggregate data, using relatively simple statistical analysis (which is easily replicable), there does not appear to be a “smoking gun”-type of relationship between corporate profits and inflation.¹⁰

One caveat is that one could cite the 0.33 correlation in the 2020 to 2023 time period compared to the very different -0.04 correlation that occurred over 2000 to 2019. That is certainly a big jump in a positive co-movement between inflation and corporate profits and could suggest corporations are behaving differently than pre-2020 when it comes to pricing.

On the other hand, corporate profits were also highly correlated with real GDP growth over the 2020 to 2023 sample, more than twice the correlation in the 2000 to 2019 span of time. This suggests what we see in the data may be the common factor of real GDP driving both corporate profits and the rise in the price goods and services.

Some alternative evidence

As one additional check, another statistic to look at is what’s called “price per unit of real gross value of nonfinancial corporate business.” This variable helps isolate the proportion of prices that can be explained by corporate profits. The root of this variable, the “gross value,” is defined as “the total value of all goods and services produced by the corporate sector (gross output) less the value of the goods and services that are used up in production (total intermediate inputs).”¹¹ The “price per unit” is the ratio of that variable measured in current dollars divided by the constant-dollar estimate. The “price per unit” is broken down to reveal the proportion that labor, non-labor inputs, and corporate profits each contribute to the price of goods and services.¹²

Figure 3 displays the share of corporate profits to the price of a unit of production for nonfinancial business since 2000.

The area of the graph shaded black identifies the 2020 to 2023Q3 period. As annotated on the figure, the average contribution of corporate profits to the price of production has increased from about 12 percent from 2000 to 2019, to 16 percent from 2020 and on. This represents a 26 percent increase in the share of corporate profits that explains the price of a good. (One can also compare those shares to the longer run average and the average share during the “Beastflation” time frame—2021Q2 to 2023Q—both values are shown on the figure.)

From the perspective of this measure, it is the case that corporate profits explain a larger part of prices since 2020. Proponents of “Greedflation” can reasonably point to this statistic to support their claims and frustrations that corporations have been taking advantage of our macroeconomic turmoil.

Does this prove the Greedflation point? No, just as the correlations discussed earlier do not disprove Greedflation either. I think ultimately the answer is it is probably a mixture of things.

There is no dispute that GDP growth was extraordinary from the third quarter of 2020 through the end of 2021. Such a dramatic increase in the output gap can easily explain the rise in inflation. Yet, amidst the growth in GDP it stands to reason that some corporations have rationalized boosting their prices rapidly, and then have taken, and will continue to take, their sweet time making any changes in the other direction.  

1. Paraphrased from Plutarch, Parallel Lives, Caesar 63 (via Wikipedia).

2. Hat tip to a former stand-out student from many years ago for this question (who wrote a senior honor’s thesis with the title “An Analysis of Fed Decision Making in the 1970's: The Effects of Money Supply Targets,” and was a member of a notable Fed Cup Challenge team along with four other stand-out students of the day, but I digress).

3. A clever moniker to be sure; though this blog still prefers “Beastflation.”

4. The BEA describes corporate profits as follows: “BEA’s featured measure of corporate profits—profits from current production—provides a comprehensive and consistent economic measure of the income earned by all U.S. corporations. As such, it is unaffected by changes in tax laws, and it is adjusted for nonreported and misreported income. It excludes dividend income, capital gains and losses, and other financial flows and adjustments, such as deduction for ‘bad debt’.” See chapter 13 of the NIPA Handbook at, https://www.bea.gov/resources/methodologies/nipa-handbook/pdf/chapter-13.pdf.

5. See chapter 2 of the NIPA handbook for details on the relationship between GDP and National Income, https://www.bea.gov/resources/methodologies/nipa-handbook/pdf/chapter-02.pdf

6. The GDP Deflator is a price index in the same vein as the PCE price index, discussed in detail here. While the PCE tracks the prices of the goods and services in the category of consumption expenditure, the GDP deflator tracks the prices of everything that is counted as part of GDP, such as investment and government expenditure in addition to consumption. I also computed the rate of inflation for the Consumer Price Index (CPI) (at the quarterly frequency) and those numbers are similar to those shown for the GDP Deflator. From 2020 and each year on, the average quarterly rates of CPI inflation were 1.2, 6.6, 6.9, and 3.4 percent, respectively. The average CPI rate of inflation over the entirety of 2020 to 2023q3 equaled 4.6 percent. 

7. These numbers are not shown on the figures, but were calculated separately by the author.

8. Macrosight previously explained correlations here. Quoting from that post: “A correlation coefficient . . . provides a measure of how two variables “move” or change together over a sample . . . the correlation of 0.20 . . . reveals a positive but not-so-strong correlation over the twenty-year period. A very strong positive correlation would be closer to 1 (a rule-of-thumb is that a correlation of around 0.70 and higher is “strong”).”

9. While this may seem surprising, it is also the case that over samples that span decades (e.g. 1950 to 2023), the correlation between the rate of GDP Growth and the rate of inflation is essentially zero. That, too, may come as surprise but, in fact, reflects a reality of market economies: in the long run the forces that dictate economic growth are independent of the forces that dictate the rate of inflation. This is known as the “Classical Dichotomy.” Macrosight will explain this further in a future post.

10. I also performed regression analysis on the relationship between inflation and corporate profits. I estimated the effect of the last four quarters of corporate profit on the current quarter’s rate of inflation. However, none of the lags of corporate profit were statistically significant (nor were they if I controlled for lags of inflation as well). I estimated over the entire 1950 to 2023 period and separately for the 2000 to 2023 sample.

11. And, “It is derived as the sum of consumption of fixed capital, compensation of employees, taxes on production and imports less subsidies, and net operating surplus.” See the appendix to chapter 13 the NIPA Handbook at https://www.bea.gov/resources/methodologies/nipa-handbook/pdf/chapter-13.pdf.

12. The full definition is, “The per-unit measures are computed by dividing current-dollar nonfinancial gross value added and its components—compensation of employees, consumption of fixed capital, taxes on production and imports less subsidies, business current transfer payments (net), net interest, and corporate profits—by real (chained-dollar) nonfinancial gross value added. The resulting quotients (divided by 100) provide the value-added implicit price index and the parts of the price index that are associated with each component. Value-added unit costs attribute the changes in the value-added unit prices to its components in proportion to each component’s share of current-dollar value added.” See the appendix to chapter 13 the NIPA Handbook at https://www.bea.gov/resources/methodologies/nipa-handbook/pdf/chapter-13.pdf.