US corporate profits have been understated in recent years because of flawed accounting practices that failed to treat companies' spending on computers properly, Mr Alan Greenspan, the chairman of the US Federal Reserve said yesterday.
The Fed chairman's remarks suggest that current sky-high stock valuations may not be quite as inflated as many analysts have argued. However, Mr Greenspan also repeated his concern that the Federal Reserve and other central banks must pay more attention to the causes and effects of asset price changes in the formulation of their monetary policy. His comments, at the Fed's annual international monetary policy symposium in Jackson Hole, Wyoming, had an immediate damping effect on markets, pushing the Dow Jones Industrial Average off record highs in the morning to be down 45.91 points at 11,152.54 in early afternoon trading. It later closed down 108.28 at 11,090.17.
Explaining how corporate profits had been understated, Mr Greenspan said some software and other types of capital spending were often treated as expenses rather than capital expenditure over the lifetime of the investment. Since there was evidence this type of spending had been growing faster than reported earnings in the last few years, underlying profits and growth had probably been stronger.
Mr Greenspan cautioned that the under-statements of official profits could not be the central explanation for the "extraordinary" run-up in stock prices in the last few years.
None of what Mr Greenspan said contradicted his repeated warnings that equity prices may have become seriously over-valued. But they indicate the Fed is examining more closely than ever the behaviour of stock and other asset prices in trying to understand the powerful forces propelling the US economy.
Central bankers needed, he said, to ascertain how changes in those balance sheets influence real economic activity and also what was behind those changes: genuine improvements in economic performance, or speculative excess. He also emphasised that this did not concern stock prices alone.
