Abstract
Prior studies document that aggregate earnings news is related to news about future inflation. We propose two alternative explanations for this relation - one based on firm’s changing their investments in response to profitability shocks and the other based on consumers varying their consumption in response to higher disposable income or greater wealth arising from increased profitability of listed firms. Since supply of goods and services is relatively inelastic in the short-run, our arguments imply that shocks to demand for investments (consumption) will affect prices of investment (consumption) goods and services. Consistent with aggregate earnings news affecting business investments, we find that profitability shocks predict investment shocks in subsequent quarters as well as shocks to Producer Price Index, which primarily tracks prices of production-related goods. We find no evidence that aggregate earnings surprises contain information about future consumption shocks or shocks to prices of consumption goods (Consumer Price Index). Our analyses also reveal aggregate earnings surprises predict future investment and PPI forecast-errors and that this forecasting inefficiency explains previously documented inefficiencies in GDP growth forecasts.
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