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FEDERAL RESERVE BANK.Of R4GHM0 NL)
MONTHLY
REVIEW
Determinants of Change In the
Money Stock: 1960-1970
Profit Size and Measurement
Profits and Wages: 1965-1970
DETERMINANTS OF CHANGE IN THE MONEY
STOCK: 1960-1970
In studying the behavior of the money supply,
analysts frequently employ the monetary base-money
multiplier approach. In this framework the stock of
money ( M ) , usually defined as demand deposits and
currency held by the nonbank public, is expressed as
the product of the multiplier (m ) and the base ( B ) ,
i.e., M = m B . The monetary base is composed of socalled “ high-powered” money— currency plus total
bank reserves.1 W hen channeled through the com
mercial banking system, this high-powered monetary
input is capable, because of fractional reserve bank
ing, of generating a monetary output equal to some
multiple of itself. The multiplier may be thought of
as a productivity ratio showing the monetary output
per dollar of base input ( m = M / B ) . A rise in the
multiplier indicates a rise in the productivity of the
base, whereas a fall in the multiplier indicates that
each dollar of the base is less productive in gen
erating money. Chart 1 shows the quarterly levels,
since 1960, of the money supply, the monetary base,
and the multiplier. The money supply is currently
about 2.58 times larger than the base. The pro
ductivity of the base has declined somewhat since
1960 when the money stock was about 2.70 times the
size of the base.
The chief distinction between the monetary base
and the multiplier is that the former is largely de
termined by the actions of the monetary authority,
whereas the latter is primarily determined by the
actions of bankers and private individuals. The com
ponents of the monetary base are liabilities of the
central bank and the Treasury. The Federal Reserve
can alter the volume of these monetary liabilities by
open market purchases and sales of U. S. Govern
ment securities. The money multiplier, on the other
hand, is composed of several ratios whose magnitudes
are determined by the decisions of commercial bank
ers and nonbank private individuals. These ratios
include (1 ) the currency/private demand deposit
ratio, k, (2 ) the time deposit/demand deposit ratio,
1 A statistical series on the monetary base has been constructed by
economists at the Federal Reserve Bank of St. Louis. To make the
base comparable over time, St. Louis analysts add a reserve adjust
ment term to the reserve and currency components of the base.
This reserve adjustment term takes into account reserves freed or
absorbed by changes in legal reserve requirements and by shifts in
the distribution of deposits among classes of banks and deposit
categories having different reserve requirements.
2
t, (3 ) the total reserve/total deposit ratio, r, and
(4 ) the Treasury deposit/private demand deposit
ratio, g. The k and t ratios reflect the public’s pre
ferences for currency and time deposits relative to
demand deposits, whereas the r ratio reflects bankers’
decisions (subject to legal reserve requirements) on
the proportion of reserves to hold against their de
posit liabilities.2 The g ratio reflects the Treasury’s
allocation of its deposit holdings between commercial
banks and the Federal Reserve. The relation of these
ratios to the money multiplier is summarized in the
formula m = (l-| -k ) -f- [r(1-j-t—
)-g) + k ] . A deriva
tion of this formula appears in Appendix B.
Much discussion has centered on the question of
the relative importance of the base and the multiplier
as sources of change in the money supply.
The
monetarist school argues that variation of the base
is the dominant determinant of money stock change.
Monetarists further hold that alterations of the money
supply have been almost exclusively the result of
Federal Reserve actions, since these actions are the
main origin of changes in the base. Monetarists
claim, moreover, that because of its stability the mul
tiplier is relatively insignificant as a source of money
stock change. Therefore, the Federal Reserve can
easily neutralize changes in the money supply arising
from changes in the multiplier, thus, controlling the
money stock within close tolerance.
The nonmonetarist school of thought, on the other
hand, maintains that sharp short-term changes in the
money stock often reflect the influence of changing
economic conditions that operate through the mul
tiplier. The impact of these multiplier changes, it
is argued, may be of sufficient magnitude to make
it difficult for the central bank to control the money
supply. Nonmonetarists point out that shifts in the
multiplier do not need to be large to exert a power
ful influence on the money supply. Even small
2 The total reserve/total deposit ratio is also determined by the dis
tribution of total deposits among classes of banks and deposits
having different reserve requirements. In the United States bank
ing system, differential reserve requirements exist between (1) Fed
eral Reserve member banks and nonmember banks, (2) reserve city
and country member banks, and (3) deposits under and over $5.0
million.
Thus, changes in the aggregate reserve ratio (r) can
result from shifts in the distribution of deposits among various bank
and deposit classifications as well as from changes in legal reserve
requirements or from bankers’ decisions to alter their reserve
positions.
M O N TH LY REVIEW, MARCH 1972
changes in the multiplier can have a large dollar im
of the relatively low required reserve ratio for time
pact. For example, an increase in the multiplier from
deposits, thereby pulling down the weighted average.
2.5 to 2.6, applied to a monetary base of $88.0 billion,
Because of such interdependencies, estimates of the
will result in a change in the money supply from
proportion of money stock change attributable to each
$220.0 to $228.8 billion, almost a $9.0 billion increase.
determinant will be subject to error.
In sum, nonmonetarists contend that because short-
suppose 10.0% of the money stock change is esti
run shifts in the multiplier have such a magnified
mated to be attributable to changes in the time deposit
For example,
dollar impact on the money supply, the Federal R e
ratio, and 30.0% to changes in the reserve ratio.
serve may experience difficulty in controlling the
These estimates may understate the contribution of
latter via alterations of the base.
the time deposit ratio to money stock change if part
This article presents data showing the relative con
of the change in the reserve ratio was induced by
tributions of the multiplier and the base to changes
changes in the time deposit ratio.
in the stock of money over the decade of the 1960’s.
mates presented below should be interpreted as
rough approximations only.
It also develops numerical estimates of the relative
contribution of each of the constituent ratios of the
multiplier to changes in the multiplier and the money
stock.
However, the reader should be forewarned
of the limitations of the analysis presented in the
following paragraphs.
Although the monetary base
and the money multiplier ratios will be treated
as separate, mutually independent determinants of
money stock change, these entities, in actuality, are
not independent of each other. Changes in one of the
determinants will induce changes in the others. A l
terations in the monetary base wrought by the Fed
eral Reserve will induce responses by banks and in
dividuals that will alter the multiplier ratios. Con
sider, for example, the effects of an increase in the
monetary base on the time deposit ratio. T o achieve
an increase in the base, the Federal Reserve may
purchase Treasury bills on the open market. The in
creased demand for these securities raises their price
and lowers their yield. The decline in Treasury bill
yields is transmitted to other short-term assets—
commercial paper, savings and loan shares, etc.—
that compete with time deposits in individuals’ port
folios. A s the yields on these alternative short-term
assets decline relative to the yield on time deposits,
wealth-holders switch from the former assets to the
latter, thereby raising the time deposit ratio. The
reserve ratio, too, may rise if banks respond to the
decline in short-term yields by holding a larger pro
portion of bank assets in the form of excess reserves.
Similarly, interrelationships also exist among the
constituent ratios of the multiplier since they are
mechanically linked to each other in an accounting
or definitional sense. For example, the reserve ratio,
r, a weighted average of the excess and legal re
quired reserve ratios associated with demand, time,
and government deposits, will fall when the propor
tion of time to demand deposits rises. A rise in the
t ratio alters the composition of the weights in favor
Thus, the esti
Contributions of Variation in the Base and the
Multiplier to Changes in the Money Stock In
order to investigate the relative importance of the
base and multiplier components as sources of money
stock change, it is convenient to state relationships
among these variables in terms of percentage rates
of change. Then, the percentage change in the money
FEDERAL RESERVE B AN K OF R IC H M O N D
3
Ta b le I
CONTRIBUTION OF MONETARY BASE AND MONEY MULTIPLIER
TO CHANGE OF MONEY SUPPLY
Percentage C ha n g e o f
Y ear
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
M ean Value of
Y early Figures
R elative C o n trib u tio n 1 o f
M oney
Stock
Base
M u ltip lie r
T o ta l2
- 1.17
1.65
2.13
2.91
3.92
4.19
4.42
3.94
7.12
5.96
4.06
0.38
2.16
3.40
4.00
4.87
4.92
4.99
4.76
6.13
4.86
4.50
- 1.54
- 0 .5 1
- 1.22
- 1.05
- 0 .9 0
- 0 .7 1
-0 .5 3
-0 .8 0
0.94
1.05
- 0 .4 1
100
100
100
100
100
100
100
100
100
100
100
3.56
4.09
-0 .5 2
100
Base
-
32.6
130.9
159.4
137.4
124.1
117.4
112.9
120.9
86.0
81.6
110.7
104.4
M u ltip lie r
131.4
30.5
57.2
36.0
23.0
16.9
12.0
20.4
13.1
17.6
10.0
-
-
4.0
1 A n e g a tiv e re la tiv e c o n trib u tio n sig n ifie s th a t th e d e te rm in a n t e x e rte d an in flu e n c e o p p o s ite to th e d ire c tio n o f ch an g e o f th e
s u p p ly .
m oney
2 Sum o f re la tiv e c o n trib u tio n s m a y n o t e x a c tly e q u a l 100 because o f ro u n d in g a n d a p p ro x im a tio n e rro r.
stock is approximately equal to the sum of the per
centage changes in the base and the multiplier.3
Over the span from 1960 to 1970 the money stock,
base, and multiplier exhibited average annual growth
rates of 4.0% , 4.5% , and —0.5% , respectively. Note
that the base and the multiplier moved in opposite
directions. The growth rate of the money supply
reflected both the upward pull of the base and the
downward pull of the multiplier. Because of the
latter, the money stock growth rate was only eightninths that of the base. But the 4.0% growth rate of
the money supply clearly reflected the dominant nu
September 1971 are chosen over which to calculate
growth rates. Over that 139 month interval, the
growth contributions of the base and multiplier were
110.0% and — 7.0% , respectively, of the total growth
of the money supply. This evidence indicates that,
over the long run, changes in the monetary base were
definitely the dominant determinant of money stock
change, and that changes in the multiplier played
merical influence of the base. In terms of the M = m B
indicated in Table I, which shows that on a yearly
identity, if the base had remained constant while the
basis the multiplier sometimes accounted for fairly
multiplier fell, the money stock would have declined
significant proportions of total changes in the money
by 0.5% per annum. If the multiplier had remained
constant while the base rose, the money supply would
have risen 4.5% per year.
of the decade, when the multiplier exhibited a posi
tive growth rate, the base accounted for 91.0% of the
The picture is roughly
the same if monthly instead of yearly data are used
and if initial and terminal dates of January 1960 and
3 More precisely, the percentage change in the money stock measured
over discrete intervals of time, such as a quarter or a year, is equal
to the percentage change in the base plus the percentage change in
the multiplier plus the product of the percentage changes in the
base and the multiplier, respectively. This last factor, however, is
usually small enough to disregard and is ignored in the discussion
of the text.
4
Over shorter periods of time, however, variations
in the multiplier have exerted greater influence on
money stock changes than in the long run.
This is
supply. The small average value of the relative con
tribution of the multiplier to money stock change is
misleading because in each year the multiplier’s con
Even over the period spanning the last four years
growth of the money stock.
only a minor role.
tribution deviated markedly from its 11 year average.
In fact, the standard deviation (a statistical measure
of variation about the mean) of the relative con
tribution of the multiplier was practically the same
as the standard deviation of the base’s contribution.
The measured magnitude and variability of the mul
tiplier on a year-to-year basis adds support to the
nonmonetarists’ claim that instability of the multiplier
may create difficulties for monetary control in the
short run.
M O N TH LY REVIEW, MARCH 1972
The short-run importance of multiplier
C h a rt 2
movements as a source of money stock change would
have been even more manifest if quarterly and
monthly changes had been examined.
Sources of Change in the Multiplier In the p re
ceding section, changes in the money supply were
attributed to changes in the base and changes in the
multiplier. This was a convenient first approxima
tion. Because the money multiplier itself embodies
several determinants of the money stock, however, a
better understanding of changes in the money supply
VALUES OF CONSTITUENT RATIOS OF THE
MONEY MULTIPLIER: 1960-1970
(A n n u a l A v e ra g e V alues)
Q RATIO
Ratios
.061------------------------------------------------------------------------------ --
requires specification of the factors contributing to
changes in the multiplier.
A s previously mentioned, the money multiplier is
composed of several ratios reflecting the portfolio
composition decisions of bankers and nonbank in
dividuals.
It is changes in these ratios that cause
changes in the multiplier.
For example, assuming
all other factors constant, a rise in the ratio of cur
rency to deposits, k, will reduce the size of the mul
tiplier.
The multiplier relation between the money
stock and monetary base falls because the rising k
ratio reduces the proportion of the base that banks
are able to acquire as reserves to support demand
deposits equal to some multiple of reserves. Changes
Y RATIO
.150 --------------------------------------------------------------------------------------------------
“
in the other ratios also act to alter the size of the
multiplier. Increases in the time, t, and government,
g, deposit ratios cause the multiplier to fall by re
ducing the share of total reserves available to sup
port the money supply.
Time and government de
posits (not counted as part of the money supply)
must be backed by legal reserves.
Growth of these
deposits relative to private demand deposits means
that a larger portion of total reserves are absorbed
to support nonmonetary liabilities.
In short, the
k RATIO
.3001--------------------------------------------------------------------------------------------------------- —*
immobilization of a growing portion of the base, as
backing behind nonmonetary deposits, lowers the
money-creating leverage of the base.
.250 -
In contrast,
a fall in the reserve, r, ratio acts to increase the
multiplier because it permits a greater amount of
.200
-
money to be created per dollar of reserves.
The yearly average values of the multiplier ratios
are shown in Chart 2.
The trends of both the time
deposit and
ratios
currency
have been
.150 '
upward,
the former ratio exhibiting substantial year-to-year
growth and the latter registering more moderate
gains.
.100
-
The reserve ratio, on the other hand, has
declined gradually but persistently.
Only the gov
.050 ■
ernment deposit ratio has shown no perceptible trend.
Table II shows the contribution of changes in each
of the ratios to year-to-year percentage changes in
1960
Source:
1962
1964
1966
Federal Reserve B ank o f St. Louis.
1968
1970
T a b le
II
CONTRIBUTIONS OF MULTIPLIER RATIOS TO CHANGES IN THE MONEY MULTIPLIER
A ttrib u ta b le to C hanges in :1
R ela tive C o n trib u tio n o f C hanges in :3
Time
D eposit
R atio
G o v e rn m e n t
D eposit
R atio
T o ta l
C o n trib u tio n
0.00
- 0 .8 4
-0 .1 6
100
37.5
0.0
52.5
10.0
0.83
-2 .0 8
0.13
100
-1 2 5 .0
-1 6 6 .7
4 16.7
-2 5 .0
100
40.0
-1 4 5 .7
188.6
100
95.5
-2 8 6 .4
295.5
-
4.5
0.09
100
128.6
-2 5 7 .1
238.1
-
9.5
Y ear
Percentage
C ha n g e in
M u ltip lie r
C urre n cy
R atio
1960
-1 .6
- 0 .6 0
1961
-0 .5
0.63
1962
-1 .2
-0 .4 8
1.75
-2 .2 6
1963
-1 .0
-1 .0 0
3.01
-3 .1 0
0.05
1964
-0 .9
-1 .1 6
2.31
-2 .1 4
Reserve
Ratio
- 0 .2 1
C urre n cy
R atio
Reserve
R atio
Time
D eposit
R atio
G o v e rn m e n t
D ep o sit
R atio
17.1
1965
-0 .7
-0 .2 7
1.18
-1 .5 9
-0 .0 3
100
38.5
-1 6 9 .2
226.9
3.8
1966
-0 .5
-0 .7 3
1.50
-1 .4 7
0 .20
100
146.7
-3 0 0 .0
293.3
-4 0 .0
1967
-0 .8
-0 .5 5
2.83
-3 .0 8
0 .00
100
69.2
- 3 5 3 .8
1968
0.9
0.09
-1 .4 9
0.65
0.03
100
10.3
165.5
1969
1.0
-0 .2 9
0.57
0.67
0.05
100
28.6
57.1
66.7
4.8
7.7
-
384.6
-
0.0
-
7 2.4
1970
-0 .4
-0 .8 9
0.74
-0 .2 2
-0 .0 3
100
223.1
-1 8 4 .6
53.8
M ean V a lu e
o f Y e a rly
Figures
-0 .5 2
- 0 .3 1
1.20
- 1 .4 1
0.01
100
57.8
-1 4 9 .2
194.9
-
3.4
3.5
1 Sum o f c o n trib u tio n s o f changes in th e m u ltip lie r ra tio s m a y n o t e x a c tly e q u a l to p e rce n ta g e ch an g e o f m u ltip lie r because o f ro u n d in g
a n d a p p ro x im a tio n e rro r.
2 I f changes o f r a tio a n d m u ltip lie r a re o f o p p o s ite sign, th e n th a t ra tio ch an g e e x e rte d a n in flu e n c e o n th e m u ltip lie r o p p o s ite to th e
d ire c tio n o f a c tu a l ch an g e o f m u ltip lie r.
3 Sum o f c o n trib u tio n s m a y n o t e x a c tly e qu a l to TOO because o f ro u n d in g a n d a p p ro x im a tio n e rro r.
4 A n e g a tiv e re la tiv e c o n trib u tio n s ig n ifie s th a t th e p a rtic u la r ra tio e x e rte d
a c tu a l ch an g e o f m u ltip lie r.
an
in flu e n c e
on
the
m u ltip lie r o p p o s ite
to
th e
d ire c tio n
of
the multiplier. The method used to derive the esti
mates appearing in the table is described in the ap
pendix to this article.
Roughly, the separate in
fluence exerted by the change in each ratio was
calculated by (1 ) estimating the percentage change
in the multiplier resulting from a small unit change
in the ratio, the other ratios being assumed constant,
and (2 ) multiplying this figure by the actual number
of units that the ratio changed over the year. For
example, if, in a given year, the multiplier tended
to decrease by one-fourth of 1 percent for every one
percentage point rise in the currency ratio, then a
yearly rise of five percentage points in the currency
ratio would, by itself, cause a 1 /4 % fall in the mul
tiplier.
The separate contribution of each deter
minant is calculated similarly, and the total of all
the separate contributions equals the percentage
change in the multiplier.
It is evident from the table that changes in the
time deposit ratio had the greatest single impact on
fluences on the multiplier. In most years the falling
reserve ratio partially offset the influence of the ris
ing time deposit ratio. The offset, however, was in
complete, and the influence of time deposit ratio
dominated. Together with the rising currency ratio,
then, the rising time deposit ratio contributed more
than enough to offset the influence of reserve ratio
changes that tended to raise the multiplier. In short,
the main factors accounting for the negative growth
rate of the multiplier were changes in the currency
and time deposit ratios.
the multiplier, with reserve ratio changes a close
reserve ratio more than offset the negative relative
second.
Taken together, however, the combined in
C onclusion T he relative contributions o f each
of the money stock determinants to yearly changes in
the money supply are summarized in Table III. The
table
indicates
that although
the base was
the
dominant determinant of money stock change, the
reserve, time deposit, and currency ratios played
significant roles. Generally, the positive relative con
tributions of the rising monetary base and the falling
contributions of the rising currency and time de
fluence of the time deposit and reserve ratio changes
posit ratios.
usually was not great. During the 1960’s the reserve
the positive growth rate of the money stock were
ratio was falling, while the time deposit ratio was
changes in the base and the reserve ratio.
rising.
6
Thus, the two ratios exerted opposite in
Numerically, the main contributors to
Jane Anderson and Thomas M . Humphrey
M O N TH LY REVIEW, MARCH 1972
Ta b le III
RELATIVE CONTRIBUTION OF EACH DETERMINANT
TO TOTAL PERCENTAGE CHANGE IN MONEY STOCK
C o n trib u tio n s 2 (p e rc e n ta g e o f to ta l) o f changes in
T o ta l
C o n trib u tio n 1
Y ear
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
100
100
100
100
100
100
100
100
100
100
100
Mean Value
o f Yearly
Figures
100
-
Base
C urrency
R atio
Reserve
R atio
Tim e
D ep o sit
R atio
32.6
130.9
159.4
137.4
124.1
117.4
112.9
120.9
86.0
81.6
110.7
49.3
38.1
-2 2 .9
-3 4 .4
-2 9 .6
- 6.5
- 17.6
- 14.1
1.3
- 5.0
-2 2 .3
0.0
50.8
83.3
103.1
59.1
28.6
36.0
72.2
21.7
10.0
18.4
68.9
- 127.1
- 107.9
- 106.4
- 54.7
- 38.3
- 35.2
- 78.4
9.5
11.7
5.4
104.4
-
5.8
43.9
-
43.8
G o v e rn m e r
D ep o sit
Ratio
-
-
-
13.1
7.6
9.8
1.6
2.2
0.6
4.8
0.0
4.4
0.8
0.8
1.3
1 Sum o f c o n trib u tio n s m a y n o t e x a c tly e qu a l to 100 because o f ro u n d in g a n d a p p ro x im a tio n e rro r.
2 A n e g a tiv e re la tiv e c o n trib u tio n s ig n ifie s th a t th e p a rtic u la r ra tio e x e rte d an in flu e n c e o p p o s ite to the d ire c tio n o f ch ange o f th e m oney
s u p p ly .
APPENDIX A
This appendix describes the techniques employed
in devoloping the estimates shown in Tables II and
III of the article. The formula used to specify the
fraction of money stock change attributable to each
of its determinants is derived from the relation be
tween the money supply, base, and multiplier
(1 ) M = Bm where m = (1 + k ) -r- [r (l-)-t—
|-g) —
1~k].
By taking the logarithm of equation (1 ) and then
calculating the total derivative of the resulting log
arithmic expression, one obtains the following ex
pression :
(2 ) d M /M = d B /B +
+
r(l+ t-fg ) - 1
dk
m [r (l+ t+ g ) + k ] 2
(1 )
(2 )
~ U + k )(l+ t+ g )
m [r (l+ t + g ) + k ] 2
(3 )
dr
(4 )
-|-
— r(l-j-k )
dt
m [ r ( l + t + g ) + k ]2
5
( )
-f
— r (H -k )
dg.
m [r (l+ t + g ) + k ] 2
6
( )
This is the formula used to determine the proportion
of the percentage change in the money stock at
tributable to each of its determinants.
The first term of the formula ( d M /M ) is the per
centage change of the money stock. It is equal to
the sum of terms (2 ) through ( 6 ) , each of which
represents the contribution of a separate determinant
to the total percentage change in the money stock.
Term (2 ) of the formula is the percentage change
in the base and also the fraction of the percentage
change in the money supply attributable to changes
in the base. Terms ( 3 ) , ( 4 ) , ( 5 ) , and (6 ) represent
the separate contributions of changes in the cur
rency ratio, reserve ratio, time deposit ratio, and
government deposit ratio, respectively, to the per
centage change of the money stock. Each of the
terms on the right-hand side of the equation is di
vided by the term on the left-hand side to obtain the
proportion of money stock change attributable to
each determinant, as shown in Table III.
The sum of the last four terms of the equation
equals the percentage change in the money multiplier.
Each of these terms, expressed as a fraction of the
total of all four of them, represents the relative con
tribution of a change in one of the component ratios
of the multiplier to the total percentage change in the
FEDERAL RESERVE B A N K OF R IC H M O N D
7
multiplier. The ratio of each term (3 ) through (6 )
change of equation (2 ) had to be approximated by
to the total of all four was employed in estimating
average yearly rates of change and the factors k, r,
the relative contribution of each determinant to the
total change in the multiplier, as shown in Table II.
t, and g had to be approximated by their average
Actually, equation (2 ) is completely valid only for
value over the year.
The use of average data to
approximate the relation shown in equation (2 ) in
the computation of instantaneous rates of change.
troduces an error into the analysis.
The data used in the text, however, were for discrete
term should be added to equation ( 2 ) . Generally, this
intervals of time.
approximation error is small enough to disregard.
Thus, the instantaneous rates of
Thus, an error
APPENDIX B:
DERIVATION OF THE M ONEY MULTIPLIER
The multiplier employed in this article differs
The volume of reserves ( R ) held by the aggregate
from the multiplier expression appearing in the de
of banks is some fraction (r ) of their deposit lia
mand deposit expansion formula shown in most
bilities, including private demand deposits ( D ) , fed
money and banking texts.
eral government demand deposits
In the textbook formula,
demand deposits equal a multiplier times the volume
deposits ( T ) :
of reserves, where the multiplier is simply the re
(5 ) R = r ( D + T + G ) .
( G ) , and time
ciprocal of the reserve ratio. The expression for the
Time deposits ( T ) and government demand de
money multiplier used in this article is derived as
posits (G ) respectively, are equal to some fraction
follows.
(t and g, respectively) of private demand deposits:
The money stock ( M ) is composed of private de
(6 ) T = tD
(7 ) G = gD.
mand deposits ( D ) and currency (C ) :
Substitution of equations ( 2 ) , ( 5 ) , ( 6 ) , and (7 )
(1 ) M = D + C.
The currency holdings of the aggregate of in
dividuals is some fraction (k ) of their demand de
posit holdings:
into equation (4 ) yields:
(8 ) B = [ r ( l + t + g ) + k ] D .
Equation (8 ) may be written a s :
(2 ) C = kD.
(9 ) D = B H- [ r ( l + t + g ) + k ] .
Finally, substitution of equation (9 ) into equa
Substituting equation (2 ) into (1 ) yields:
(3 ) M = ( l + k ) D .
The monetary base ( B ) is defined as the sum of
tion (3 ) yields:
reserves ( R ) and currency (C ) :
The expression enclosed by braces is the money mul
(4 ) B = R + C .
tiplier, the ratio of M to B.
(1 0 ) M =
{ [1+ k ] -H [ r ( l + t + g ) + k ] } B.
Bibliography
Ahrensdorf, J. and S. Kanesathasan. “ Variations in the
Money Multiplier and Their Implications for Cen
tral Banking,” International M onetary Fund S ta ff
Papers, 8 (1 9 6 0 -6 1 ), 126-49.
Cagan, Philip. Determinants and E ffe c ts o f Changes in
the Stock of M o n ey 1875-1960. New Y o rk : National
Bureau o f Economic Research, 1965. pp. 8-21.
Friedman, Milton and Anna J. Schwartz. A M onetary
H istory o f the United States. Princeton: Princeton
University Press, 1963.
pp. 794-95.
8
Jordan, Jerry L. “ Elements o f Money Stock Determina
tion,” Federal Reserve Bank of St. Louis Review
(October 1 9 6 9 ), pp. 10-19.
Kelly, A lex K . “ Sources o f Change in the Canadian
Money Stock, 1955-65,” Banca Nazionale del Lavoro
Quarterly R eview (1 9 6 9 ), pp. 395-407.
Weintraub, Robert. “ The Time Deposit-Money Supply
Controversy.”
Targets and Indicators o f M onetary
Policy.
Ed. K . Brunner. San Francisco: Chandler
Publishing Company, 1969. pp. 300-12.
M O N TH LY REVIEW, MARCH 1972
PROFIT SIZE AND MEASUREMENT
The subject of profit is the focus of a bewildering
array of opinions and a wide variety of interpreta
tions. Popular views range all the way from a “ fat
cat” theory, which holds that profit arises from the
rapacious exploitation of consumers and wage-earners, to a “ seed corn” theory, which holds that profit
is an indispensable source of capital expansion and
economic growth. Economic theory, too, offers a
diversity of explanations of profit. Does profit arise
from monopolistic restrictions on output and access
to the market? From unforeseen changes in demand
and costs? From innovation? From the need to re
ward entrepreneurs for risk-bearing and decision
making? From frictions that delay the adjustment
of firms, industries, and markets to equilibrium po
sitions following the disruptions of dynamic change?
Economists cannot agree. Each of these explanations
has its adherents. Most likely, none of the explana
tions will ever be unanimously accepted as the most
correct.
The abundance of profit theories is matched by the
profusion of misconceptions about the magnitude of
profit. The average American apparently thinks that
accounting profit per dollar of sales of manufactur
ing corporations is about seven times its actual level.
This was revealed recently when the Opinion R e
search Corporation asked a sample of 1,000 adults
what they thought the average manufacturer makes
in after-tax profit as a percent of each sales dollar.
The median response was 28.0% , far larger than the
4.0% margins actually earned by manufacturers in
1970.1 Moreover, two-thirds of those questioned
displayed further ignorance of the size of profit
margins when they agreed that firms could pay a
ten cent per hour wage increase without raising
absolute magnitudes. Thus, although profit may be
expressed as an aggregate dollar total, it is often
more meaningful analytically when expressed as a
ratio to, or percentage rate of return on, related
economic variables. The most widely used profit
rates are the ratio of corporate profit to : (1 ) net
national product ( N N P ) , ( 2) income originating in
the corporate sector, (3 ) sales, and (4 ) stockholders’
equity. The first two of these ratios are measures
of profit’s share in the aggregate income distribution.
Note that the denominator of the p ro fit/N N P ratio
is more comprehensive than the denominator of
the second ratio, which includes only that portion
(roughly 6 0 .0 % ) of the N N P produced by private
corporations. The third, or profit/sales, ratio is the
margin of profit on each dollar of sales. It also in
dicates the ratio of average price to cost per unit of
output. For example, a profit/sales margin of 5.0%
implies that unit cost is 95.0% of unit price. Finally,
the ratio of profits to equity measures the rate of re
turn on the book or historical value of owners’ in
vestment in the corporations.
Chart 1 shows quarterly figures since 1951 for each
of these profit ratios. The profit rates on sales and
on equity refer to manufacturing only, whereas the
other two profit rates are for the entire corporate
sector. In all cases profits are measured after taxes.
Notice that the profit rate on equity is about double
or triple the profit rate on sales. The source of
this disparity is the sales/equity or capital turnover
ratio, which has a numerical value varying between
two and three. Similarly, profit’s share of N N P is
approximately three-fifths the size of profit’s share
prices.
W ith the purpose of dispelling some of the mis
conceptions about profit, this article discusses the
is produced in the corporate sector.
of income originating in corporations, reflecting the
fact that only about 60.0% of the national product
Behavior of Profit
T h e inform ation show n in
size and behavior of corporate profits over the past
Chart 1 reveals several noteworthy characteristics of
20 years and describes the chief empirical measures
the behavior of profit.
of profit.
tively low, contrary to the conviction held by many
Measures of Profit In econom ic analysis, re
lative magnitudes are usually more revealing than
1 Business Week, December 18, 1971, p. 26.
First, profit rates are rela
antibusiness critics and to the opinion of the man in
the street.
Over the entire 20-year period the share
of profit in N N P and in income originating in cor
porations averaged only about 6.0% and 11.0% re-
FEDERAL RESERVE B A N K OF R IC H M O N D
9
C ha rt 1
VARIOUS PROFIT RATIOS:
1951-1971
Percent
20
Ratio, p ro fits [a fte r ta xe s] to income o rig in a tin g , to rp o ra te , a ll industries
18 -
Ratio, p r o f i t s [ a f t e r t a x e s ] to S t o c k h o l d e r s ' e q u i t y , m a n u f a c t u r i n g c o r p o r a t i o n s
Ratio, p r o f i t s [ a f t e r t a x e s ] to NNP, c o r p o r a t e , a ll i n d u s t r i e s
Ratio, p ro fits [a fte r ta x e s ] to sales, m a nu facturin g corporations
16
14
-
12
-
10
6
-
4
-
_L
1>
1951
N ote:
1952
1953
1954
1955
1956
1957
1958
1959
1960
1962
1963
1964
1965
1966
_L
_L
1967
1968
1969
1970
1971
Shaded areas represent periods o f business recessions as d efin e d by the N a tio n a l Bureau o f Economic Research.
Sources:
U. S. D epartm ent o f Commerce, Business C onditions Digest; Federal Trade Commission, Q u a rte rly Financial Report
fo r M a nu fa c tu rin g C orporations.
spectively. Even in the relatively high-profit years of
1951, 1965, and 1966 these two ratios did not exceed
8.5% and 16.0%. Similarly, manufacturing profit
per dollar of sales averaged only about 4.8% over
the whole period and rarely exceeded 5.5% .
Second, the four profit rate measures have shown
no appreciable upward or downward long-run trend.
Apparently, price increases over the long run have
been sufficient to prevent rising unit labor costs
from encroaching on profit’s share and profit mar
gins. More precisely, the trend percentage change in
the price level has been approximately equal to the
difference between the percentage rise in hourly wage
rates (including fringe benefits) and man-hour
productivity.
Third, in contrast to their long-run stability, the
aggregate profit measures exhibit noticeable short-
10
1961
run movements, generally rising in the recovery
stage of the business cycle and falling in the boom
and recession stages. O f the four series, profit’s share
of income originating in the corporate sector exhibits
the most pronounced cyclical variation. A s G N P re
bounds sharply in the recovery stage, business firms
normally experience declines in both unit fixed and
unit labor costs, the former because of the spreading
of overhead expenses over rapidly expanding output
and the latter because of the registering of aboveaverage gains in labor productivity. This decline in
unit production costs leaves a growing share of sales
revenue for profit. Profit’s share may be further
augmented if firms enjoying some degree of m o
nopoly power respond to the increase in aggregate
demand by raising prices as well as output.
In the boom and recession stages, however, profit’s
M O N TH LY REVIEW, MARCH 1972
share falls as increasing costs absorb a growing pro
portion of revenues.
Labor productivity growth
slackens and wage increases accelerate causing unit
labor costs to rise. Moreover, unit fixed costs stop
falling in the boom, as firms approach their capacity
output levels, and may rise in the recession, as busi
nessmen cut back production. In short, during the
boom and recession stages, rises in unit production
costs tend to exceed price increases, thereby reducing
profit’s residual share of revenues per unit of output.
Fourth, profit rates suffered a drastic decline in
the late 1960’s. By 1970 profit rates had fallen to
their lowest postwar levels. Accounting for the
abnormally severe squeeze on profits w ere: (1 ) stag
nant productivity grow th; (2 ) wage increases sub
stantially in excess of the limited productivity gains,
with the consequent rise in unit labor costs sur
passing the rise in selling prices; and (3 ) high unit
fixed costs associated with depressed rates of ca
pacity utilization (Chart 2 ).
In 1971, as the economy emerged from its fifth
postwar recession, profit rates began to recover from
their lows of the preceeding year. Economists are
predicting a substantial rise in the dollar volume of
profits in 1972 as a result of the expected 9.0% ex
pansion of G N P. Only modest gains, however, are
anticipated for profit margins and profit’s share of
GN P. In fact, these gains are not large enough to
bring the profit’s share of G N P up to its 20-year
trend value.
C h a rt 2
SOURCES OF THE PROFIT SQUEEZE:
1966-1970
R apidly rising w ag e rates com bined w ith
sluggish p ro d u ctivity g ro w th to produce. . .
10
8
C om p e n sa tio n
p er m an
O u tp u t p e r m an
-
h o u r*
h o u r*
Pi:_ _ _ _ _ _ _
percentage rises in unit labor costs in
excess of percentage rises in selling prices.
These forces, together w ith . . .
rrice s
» lili III!
fa llin g rates of capacity u tiliza tion ,
Overstated Profit Figures Some econom ists b e
lieve that reported statistics on corporate profit, such
as those appearing in Chart 1, represent a con
siderable overstatement of true profit.
In other
words, as low as measured profit has been in recent
years, actual economic profit was even lower. These
analysts argue that certain corrections should be
made to the official profit figures to eliminate the
upward bias. Any downward adjustment would, of
course, establish the profit ratios at levels below
those shown in Chart 1. Profit overstatement springs
from two sources: (1 ) understated depreciation
charges and (2 ) implicit interest costs contained in
the profit figures.
acted to squeeze p ro fits' share.
P ro fits a fte r ta xe s as a perce n t o f
gross p ro d u c t o f n o n fin a n c ia l
c o rp o ra tio n s
Inflation and Historical Cost Depreciation H is
torical cost amortization is one source of bias in the
profit figures.
Standard accounting practice spreads
the original cost of capital equipment over its useful
1966
life by allocating to annual depreciation expense a
portion of that original cost.
In other words, the
annual depreciation charge is expressed in terms of
dollars of past,
rather than current,
purchasing
‘ P rivate n o n fa rm
Sources:
1967
1968
1969
1970
econom y.
C ouncil o f Economic A d viso rs, Econom ic R eport
o f the P resident, J a n u a ry 1972; S urvey o f C ur
re n t Business, J a n u a ry 1972; Federal Reserve
B u lle tin .
power. W hen inflation occurs, past dollars differ
from current dollars.
Each past dollar is now
equivalent to more than one current dollar in pur
chasing power. Prevention of inadequate amortiza
tion charges during inflation requires that the his
torical cost of depreciation be translated into current
dollars of equivalent purchasing power.
But this
usually is not done. Consequently, depreciation ex
pense is understated, and profit is overstated.
Similarly, profit distortion may result during in
flation if accountants charge to current expense the
prior-period acquisition cost of inventory used up in
current production. This source of upward bias in
profit could be largely eliminated if accountants ex
pressed inventory consumption cost in terms of the
inflated price level of the current period, instead of
the lower price levels of the past. But this remedy
is not always applied either.
The magnitude of profit overstatement resulting
from the failure to fully adjust depreciation and in
ventory consumption expenses for inflation has been
estimated by several analysts, including George
Terborgh,2 former research director of the Ma
chinery and Allied Products Institute, and Solomon
Fabricant of the National Bureau of Economic R e
search.3
Terborgh’s estimates indicate that the
cumulative overstatement of profit since 1951 has
been slightly in excess of $90.0 billion, with about
$32.0 billion of the overstatement occurring in the
three-year period 1968-1970 and $25.0 billion in the
two-year interval of 1969-1970 alone. These sums
represent errors of 18.0%, 31.0%, and 39.0% re
spectively of the corrected profit figures for the in
dicated years.
Apparently the degree of profit dis
tortion tends to vary directly with the rate of in
flation, which was 2.1% , 5.6% , and 5.9% respectively
over the three periods.
The effect on the profit-share ratios of Terborgh’s
revision of the profit figures is indicated in the
The estimated percentage overstatement of the re
ported profit ratio is greater for the recent period of
high rates of inflation than for the earlier period,
which was marked by lower rates of inflation.
H ow would Terborgh’s adjustments affect the
other profit ratios? The adjusted profit/sales ratio
would bear the same proportional relationship to the
reported ratio as Terborgh’s adjusted profit figures
bore to the reported profit figures. The percentage
adjustment to the profit rate on equity, however,
would be expected to exceed the percentage adjust
ment to profits and to the profit/sales ratio. Unlike
the latter ratio, which has only its numerator re
vised, the profit/equity ratio must have both nu
merator and denominator adjusted for inflation. The
denominator of the profit/sales ratio needs no ad
justment since it is already stated in current dollars.
Stockholder’s equity, however, is measured partly in
terms of dollars of past periods. T o eliminate the
inflationary bias in the profit/equity ratio, both de
preciation expense and equity must be translated into
the current-dollar equivalents of the purchasing
power of their historical or book values. If physical
assets were to be measured at current rather than
historical cost, stockholder equities would be larger
than those shown on the balance sheets by the dollar
difference between the current and historical stated
net value (net of depreciation reserves) of the assets.
The profit/equity ratio is, therefore, reduced more,
proportionately, than are the ratios of profit to cur
rent flows such as product or sales.
Unfortunately, there are no reliable estimates for
recent years of the aggregate profit/equity ratio ad
justed for inflation.
The closest substitutes are
George Stigler’s estimates of the adjusted profit rate
on total assets of manufacturing corporations, 19481957. Stigler’s estimates indicate that, in each year,
the profit/asset ratio expressed in current dollars
fell short of the ratio measured in terms of the book
values of the assets.4 On the average, the size of the
following table.
corrected ratio was only about two-thirds the size
AVERAGE ANNUAL RATIO OF CORPORATE
AFTER-TAX PROFIT TO INCOME ORIGINATING
IN THE CORPORATE SECTOR, SELECTED PERIODS
(1) R atio as re p o rte d
1951-1967
1968-1970
.119
.091
.103
.069
15.8%
31.3%
(3) P ercentage o v e rs ta te m e n t
o f ra tio - {[(1 ) -
( 2 )]-f-(2 )f
Im plicit Interest
riving at a figure for true or purely residual profit
12
Implicit
interest is the yield or interest return that stock
holders could realize on their capital if they invested
it elsewhere.
2 George Terborgh, Essays on Inflation, (Washington, D. C.: Ma
chinery and Allied Products Institute, 1971), pp. 52-56.
3 Solomon Fabricant, “ Inflation and the Lag in Accounting Practice”
in Accounting in Perspective: Contributions to Accounting Thought
by Other Disciplines (Cincinnati: South-Western Publishing Com
pany, 1971), pp. 139-141.
A second deduction from the
official profit statistics that should be made in ar
is the implicit interest on owners’ capital.
(2) R atio a d ju s te d fo r
price ch an g e
of the unadjusted ratio.
Although not treated as a cost in con-
4 George J. Stigler, Capital and Rates of Return in Manufacturing
Industries (Princeton: Princeton University Press, 1963), Tables 2
and 5 of Errata Statement.
M O N TH LY REVIEW, MARCH 1972
ventional accounting practice, implicit interest is
actually the cost of attracting equity capital from its
highest-paying alternative opportunity. In the long
run, if these opportunity or transfer cost payments
are not met out of reported profit, then stockholders
will transfer their funds elsewhere. Deduction of
implicit interest from reported profit is merely a way
of stating that this portion of profit is not a true
surplus but is a cost of attracting capital.
Instead of deducting implicit interest return from
aggregate profit, it is easier to subtract the implicit
interest rate from the profit rate on equity. For ex
ample, if the profit rate on equity is 9.0% and the
implicit interest rate is 5.0% , then the net surplus
profit rate would be 4.0% .
It is impossible, of course, to determine with ab
solute precision the implicit interest rate. Because of
the heterogeneous nature of alternative investment
opportunities and because of imperfections in the
capital market, the same opportunity cost rate will
not be applicable for all stockholders and firms.
Moreover, even if the opportunity cost rate could be
represented by a single market rate, it is difficult to
determine whether the selected rate should exclude
or include a premium for risk. One might argue for
a riskless rate, such as the rate on government bonds,
on the grounds that, for the entire population of cor
porations, the risk rewards of successful firms should
cancel out against the losses of unsuccessful ones.
Others might argue for a market rate that reflects
some degree of risk, e.g., the yield on triple or
double-A rated corporate bonds, on the grounds that
in our dynamic economy, default risks are positive
even for the aggregate of corporations and that some
minimum risk premiums are necessary payments for
the unpleasant task of uncertainty-bearing.
In the calculations below, the average interest rate
on government bonds has been arbitrarily chosen to
represent the implicit interest rate.
The reader
should be aware, however, that other analysts might,
with equal justification, select other market yield
rates to represent the implicit rate. The government
bond rate serves as a proxy for the pure interest or
riskless rate of return. Subtracting this rate from
the estimated profit rate on equity, corrected for in
flation, one obtains an estimate of the pure or surplus
rate of profit. The inflation-corrected profit rate was
estimated to be two-thirds of the reported profit rate,
the same as in Stigler’s study of the profit rate on
assets, referred to previously. For want of more
appropriate estimates, Stigler’s figures are employed.
ESTIMATED PURE OR SURPLUS PROFIT RATE
SELECTED PERIODS
(1) R eported a fte r - ta x p r o f it
ra te on e q u ity ,
m a n u fa c tu rin g .
1951-1960
1961-1968
1969-1970
10.68%
10.93%
10.40%
(2) P ro fit ra te co rrected fo r
in fla tio n [ ( l ) x % ]
7.11%
7.28%
6.97%
(3) Less: Estim ated Im p lic it
In te re s t Rate
3.14%
4.27%
7.44%
(4) Pure ra te o f p r o fit
on e q u ity
3.97%
3.01%
-
0.47%
The reader is warned not to put too much faith in
the accuracy of these figures. A s mentioned pre
viously, it is doubtful whether the government bond
rate appearing in line three of the table corresponds
perfectly to the implicit interest rate. Furthermore,
the two-thirds correction factor shown in line two was
based on a study pertaining to 1948-1957, a period
not entirely comparable to the period covered in this
article. The applicability of this correction factor to
1969-1970 is especially dubious. It is quite likely that
in these two years the inflation allowance should be
larger and the inflation-corrected profit rate smaller
than the rate shown in the table. In short, because
of the crudeness of the estimated adjustments shown
in lines two and three of the table, the pure profit
figures appearing in line four are rough approxima
tions only, still subject to error. Nevertheless, the
figures are indicative of the direction of movement
of the surplus profit rate over the past two decades.
The figures suggest that in the late 1960’s sharply
declining accounting profits combined with a high
opportunity cost rate of interest on equity to reduce
noticeably the surplus profit rate below its 19511968 levels.
C onclusion O ver the past 20 years reported
profit rates generally have been lower than many
people realize. Toward the close of the 1960’s, more
over, some of these rates plunged precipitously and
by 1970 had reached their lowest levels since W orld
W ar II. Removal of historic cost error further
shrinks the profit rates, and when the element of
implicit interest cost is extracted, they become even
more slender. The cushion of pure surplus or resi
dual profit, upon which business enterprise is often
said to rest, has never been very thick, and in recent
years it may have vanished altogether.
Thomas M. Humphrey
FEDERAL RESERVE B AN K OF R IC H M O N D
13
PROFITS AND WAGES: 1965-1971
Chart 1:
After-Tax Profits of All Nonfinancial
Corporations
After-tax profits of all nonfinancial corporations
increased slightly between 1965 and 1968 to nearly
proved profits picture in 1971 tends to support fore
casts of substantial economic gains for 1972.
Chart 2:
$42.0 billion, and then declined steadily during the
general economic slowdown of 1969 and 1970 to well
below $30.0 billion. Although the low point in profits
of $27.8 billion in late 1970 was primarily a result
of the automobile strike in the fall of 1970, sub
stantial increases in labor costs, in the face of only
moderate gains in sales revenues, accounted for the
1969-1970 decline. Recovery from this decline began
in early 1971, paralleling a step-up in the pace of
economic activity, and since that time total profits
have risen markedly. Since profits are often regarded
as a “ leading indicator” of economic activity, the im
After-Tax Profits as a Percent of Stock
holders' Equity—Manufacturing Corpora
tions Only
Return on stockholders’ equity reached its post
W orld W ar II peak in 1966. Thereafter, it began a
steady decline that lasted through 1970. The return
on equity depends on both profits and stockholders’
equity. During the latter 1960’s stockholders’ equity
increased fairly steadily, while profits actually de
clined. Thus, there was a decrease in the return on
stockholders’ equity. Such declines in the return on
equity tend to dampen investor enthusiasm and gen
erally contribute to poor stock market performance,
as was observed in 1969 and 1970. Since early 1971,
however, the return on equity has tended to improve,
as profits have increased.
Chart 3:
Wages and Salaries Paid by Nonfi
nancial Corporations
From 1965 until the general level of economic ac
tivity slowed in late 1969, total wages and salaries
paid by nonfinancial corporations increased at about
an 8.0% annual rate. W ith the slowing of economic
activity in late 1969, the demand for goods and
services tapered off and many firms reduced employ
ment and consequently their total wage bill. These
cutbacks accounted for the leveling off in total wages
and salaries paid during 1970. Improved economic
conditions and substantial wage increases in several
major industries contributed to the rapid increase in
wages and salaries paid in 1971.
Chart: 4
Wages and Salaries and Profits as a
Percent of Sales
Wages and salaries as a percent of sales and pro
fits as a percent of sales both fluctuated within a
narrow range from 1965-1971. Although wages and
salaries by themselves exhibited a dramatic increase
during this period (Chart 3 ), sales increased suf
ficiently to prevent a major decline in profit margins.
By 1971, sales increased faster than wage costs, al
lowing profit margins to improve.
14
MO N TH LY REVIEW, MARCH 1972
Although profit
C h a rt 2
AFTER-TAX PROFITS AS A PERCENT OF STOCKHOLDERS' EQUITY
MANUFACTURING CORPORATIONS
Percent
16.0
14.0
12.0
10.0
8.0
6.0
-
4.0
2.0
III IV
1965
Source:
1966
1967
1968
1969
1970
1971
Federal T ra d e C om m ission, Q u a rte rly F in a n cia l R ep o rt fo r M a n u fa c tu rin g C o rp o ra tio n s .
margins have historically declined in the second year
of a business expansion, several factors suggest that
this pattern may not hold in 1972. First, the im
provement in profit margins in 1971 was relatively
small. Second, gains in productivity, which serve to
offset wage increases, are expected to be substantial
in 1972. Finally, the new investment tax credit will
reduce the effective tax rate for many corporations,
which has a positive effect on after-tax profit margins.
Chart 5:
Factors Affecting Profit Margins for
Manufacturing Firms
It is well known that at least two economic
measures have a high degree of statistical correlation
with profit margins. A s shown in Chart 5, these
measures are a capacity utilization index and a per
unit labor cost index. The capacity utilization index
may be interpreted as an indicator of the impact of
fixed costs on profit margins, while the index of
labor costs per unit of output may be interpreted as
an indicator of the impact of variable costs on profit
margins. A s the capacity utilization index fell during
late 1969 and 1970, firms produced fewer units of
FEDERAL RESERVE B A N K OF R IC H M O N D
15
C h a rt 4
C hart 5
WAGES AND SALARIES AND PROFITS AS A
PERCENT OF SALES
FACTORS AFFECTING PROFIT MARGINS FOR
MANUFACTURING FIRMS
Percent
1967=100
Percent
21.0
W a g es a n d sa la ries as a % o f sales
20.0
19.0
4.0
A fte r -ta x p ro fits as a % o f sales
2.0
I I I > 1 I 1.1 1
. . I
1965
Sources:
1966
1967
1968
_L
1969
1970
_L_l_
1971
B oa rd o f G o ve rn o rs, Federal Reserve System ;
S urvey o f C u rre n t Business.
output over which to spread fixed costs. Thus, pro
fits per dollar of revenue also declined. The index of
labor costs per unit of output is a ratio of hourly
wage rates and productivity or output per man hour.
The increase in this index, beginning in 1969, re
Sources:
Survey o f Current Business; Federal Trade Com
mission, Q u a rte rly Financial Report fo r M a nu
fa c tu rin g C orporations.
flects both rising wage rates and declining produc
tivity. Combined, these two factors suggest that cost
per unit was increasing substantially during 19691971, which had a downward effect on profit margins.
Philip H. Davidson
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16
M O N TH LY REVIEW, MARCH 1972
@FedFRASER