Why Does Aggregate Earnings Growth Reflect Information About Future Inflation?

Posted: 23 Jan 2017

See all articles by Lakshmanan Shivakumar

Lakshmanan Shivakumar

London Business School

Oktay Urcan

University of Illinois at Urbana-Champaign

Multiple version iconThere are 2 versions of this paper

Date Written: December 6, 2016

Abstract

We propose two explanations for the previously documented relation between aggregate earnings growth and future inflation: one based on firms changing their investment in response to earnings growth and the other based on consumers varying their consumption in response to wealth effects of profitability growth. As the supply of goods and services is relatively inelastic in the short run, our arguments imply that changes to near-term demand for investment (consumption) will affect the prices of investment (consumption) goods and services. Consistent with the investment-based argument, we find that profitability changes predict investment and Producer Price Index (PPI) shifts in subsequent quarters. Our analyses also reveal that aggregate earnings growth predicts future investment and PPI forecast errors. We find, at best, weak evidence for the consumption-based link between aggregate earnings growth and future inflation.

Keywords: Aggregate Earnings, Inflation, Investments, Macroeconomic Forecasts

JEL Classification: B22, E01, E22, E31, M41

Suggested Citation

Shivakumar, Lakshmanan and Urcan, Oktay, Why Does Aggregate Earnings Growth Reflect Information About Future Inflation? (December 6, 2016). The Accounting Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2902873

Lakshmanan Shivakumar (Contact Author)

London Business School ( email )

Regent's Park
London, NW1 4SA
United Kingdom
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HOME PAGE: http://faculty.london.edu/lshivakumar/

Oktay Urcan

University of Illinois at Urbana-Champaign ( email )

515 E. Gregory Drive
4009 BIF MC-520
Champaign, IL 61820
United States
217-265-0383 (Phone)
217-244-0902 (Fax)

HOME PAGE: http://business.illinois.edu/profile/oktay-urcan/

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