Nice Graph To Show Why Inflation Is Low

| About: ProShares Inflation (RINF)

By Edward Lambert

Watching the videos of Anwar Shaikh, he presented an idea relating inflation to the net profit rate.

Net profit rate = Corporate profit rate - effective Fed rate

His view is that inflation will occur when the profit rate is squeezed by the base Fed rate. When net profit rate is low or even negative, inflation tends to occur because low net profit rates hinder investment and economic growth, and an attempt to stimulate the economy would show up as inflation of prices instead of an increase in GDP. He used this reasoning to explain the stagflation of the 70s.

So I went to FRED and made a quick graph… (link to data) (Annual data from 1958 to 2015)

The pattern is clear. When net profit rates are high, inflation must be low. In 2015, the annual data showed a high net profit rate of 8% with a low core inflation rate of 1.8%. When net profit rate reached -10% in the 1970s, inflation went high.

Let's put the current core inflation rate into the trendline equation to estimate how the current net profit rate might be changing.

Core inflation = 2.2% = 3.534*e(-11.16*x)

Estimated net profit rate = x = 4.2%

So the net profit rate may have dropped from 8% to 5% in the last year. The rise in core inflation may be showing that net profit rates are falling. That would not be a good sign, because lower net profit rates slow down growth and investment which leads to an economic contraction.