> We document the importance of import prices and domestic profits as a counterpart to the recent increase in euro area inflation. Through a novel consumption deflator decomposition, we show that import prices account for 40 percent of the average change in the consumption deflator over 2022Q1 – 2023Q1, while domestic profits account for 45 percent. The increase in nominal profits was largest in sectors benefiting from increasing international commodity prices and those exposed to recent supply-demand mismatches. While the results show that firms have passed on more than the nominal cost shock, and have fared relatively better than workers, the limited available data does not point to a widespread increase in markups. Looking ahead, assuming nominal wage growth of around 4.5 percent over 2023-24 – slightly below the level seen in Q1 2023 – and broadly unchanged productivity, a normalization of the profit share to the average level over 2015-19 will be necessary to achieve a convergence of inflation to target over the next two years. Monetary policy will thus need to remain restrictive to anchor expectations and maintain subdued demand such that workers and firms settle on relative price setting that is consistent with disinflation.
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This is relying on a novel approach that hasn’t been peer reviewed, so we aren’t going to jump to a bunch of conclusions, right?
In the US, these statistics are recorded. It is very easy to say that corporate profits are increasing...because corporate profits are reported.
In the EU, these statistics aren't recorded so it is very hard to say whether this is correct or why. This paper is built from the very top-level of stats, I don't see any problem with the theory (decomposing the GDP deflator into components) but the lack of granularity with the data is problematic imo, particularly when you are looking at explanations.
In particular, as the paper acknowledges, previous periods showed that firms increased their profit share because they expected future wage increases. This is one of the problems with the data in that there is lags and leads, granular data allows you to more precise about why this is happening.
Also, equating the GDP deflator with actual profitability seems extremely unsound to me. In aggregate, fine. But the paper is talking about profit share not actual profitability. So profits can actually fall, and this method can show they are increasing...that is possible.
Either way, this paper isn't particularly useful and, as the authors well know, everyone will read what they want into this. It is known that the EU has poor competition, it is known that wage growth is probably the most important component of inflation...there isn't really anything particularly new here.
A better thing to keep in mind is if your economy is in a wage inflation cycle where companies are increasing the amount of money to pay out to employees because their costs are increasing which makes inflation goes higher and higher. It wouldn’t be as companies are just hiking prices but, YMMV. I also don’t want to say that corporate profits are something to desired for and that the outcome that the paper outlines isn’t good or bad.
https://www.imf.org/en/Publications/WP/Issues/2023/06/23/Eur...
Here’s the abstract:
> We document the importance of import prices and domestic profits as a counterpart to the recent increase in euro area inflation. Through a novel consumption deflator decomposition, we show that import prices account for 40 percent of the average change in the consumption deflator over 2022Q1 – 2023Q1, while domestic profits account for 45 percent. The increase in nominal profits was largest in sectors benefiting from increasing international commodity prices and those exposed to recent supply-demand mismatches. While the results show that firms have passed on more than the nominal cost shock, and have fared relatively better than workers, the limited available data does not point to a widespread increase in markups. Looking ahead, assuming nominal wage growth of around 4.5 percent over 2023-24 – slightly below the level seen in Q1 2023 – and broadly unchanged productivity, a normalization of the profit share to the average level over 2015-19 will be necessary to achieve a convergence of inflation to target over the next two years. Monetary policy will thus need to remain restrictive to anchor expectations and maintain subdued demand such that workers and firms settle on relative price setting that is consistent with disinflation.
…
This is relying on a novel approach that hasn’t been peer reviewed, so we aren’t going to jump to a bunch of conclusions, right?