More on missing downward price pressure (hint, blame corporate profits)
Paul Krugman has been writing (and linking to helpful pieces) about the “missing deflation” of recent years. Despite lots of hand-wringing that activist macroeconomic policy (especially the large degree of easing done by the Federal Reserve) is laying the powder for an explosion of inflation, it’s clear that this is the wrong worry and that the extraordinary degree of economic slack actually argues that disinflation is much more likely, and is actually a problem (by the way, Ken Rogoff is totally right about this one).
But Krugman notes it’s actually a puzzle that disinflation (a reduction in the rate of price-growth) has not been ongoing and has not pushed over into outright deflation (falling prices) like in Japan. And even in Japan, prolonged economic weakness has not led to accelerating deflation, instead their deflation has been slow and steady. So what’s happening?
Krugman and others have usefully pointed to downward nominal wage rigidity as the key reason—for whatever reasons, workers seem to really not like, and employers seem to indulge their preference for, outright nominal wage cuts. Wages holding steady while inflation reduces their purchasing power? That happens—and it’s happening a lot these days. But outright nominal wage reductions are rare, and this rarity could well be providing a (useful) floor to disinflation.
But, I’d also note something else holding up prices—the determination of the corporate sector to earn historically high profit margins. The Bureau of Economic Analysis (BEA) has a great table on prices and unit labor and profit costs for the non-financial corporate sector, which accounts for just about half of the U.S. economy. In the NFC sector, prices per unit of output since the end of the recession are up just 4.1 percent. But labor costs per unit of output are down by 1.1 percent. Given that labor costs are more than 60 percent of overall prices in the NFC sector and that they’re falling, this must mean some other cost component in the production process with a much smaller share is rising a lot to drive prices up.
Meet corporate profits per unit—up 63 percent (60 percent after-tax) since the recession’s end. In fact, the growth in after-tax corporate profits can explain all of the 4.1 percent price increase between the end of the recession in the middle of 2009 and the end of 2012 (see the figure below for a breakdown).
There are many good reasons to think that upward pressure on prices is a useful thing in the U.S. economy right now, but I’m not sure that rising profits is one of them.