Economic Report President

Chart 2-8 Corporate Profits and Net Interest PaymentsThe corporate profit share of national income has risen recently while the net interestshare has fallen. The sum of these pieces of capital income has varied less.Percent of national income201816Corporate profits + net interest141210Net interest8Corporate profits60475:Q1 77:Q1 79:Q1 81:Q1 83:Q1 85:Q1 87:Q1 89:Q1 91:Q1 93:Q1 95:Q1 97:Q1Note: Corporate profits includes inventory valuation and capital consumption adjustments.Source: Department of Commerce (Bureau of Economic Analysis).for investment—have also made up an unusually large share of nationalincome in recent years.Profits can affect investment in two ways. First, high returns toexisting capital may help persuade firms that the return to new capitalinvestment will be high as well. Second, high profits allow firms to purchasecapital using internally generated funds, which are generallyless expensive to the firm than external funds (the proceeds of borrowingor the sale of shares). This difference in cost arises because lendersknow less about a firm’s investment projects and financial conditionthan the firm itself does. Their informational disadvantage creates socalledagency problems, which include both moral hazard (firms mayalter their behavior in ways that raise their lenders’ risk without thelenders’ knowledge or acquiescence) and adverse selection (firms thatseek external funds will tend to be those with riskier projects). Thus,the information asymmetry between firms and potential lenders raisesthe cost—and sometimes restricts the quantity—of funds raised infinancial markets.Plentiful External CapitalA third reason for the impressive recent pace of investment has beenthe ready availability of external funding. In particular, the dramaticreduction in Federal Government borrowing has left more resourcesavailable for private use. The domestic source of new loanable funds inthe economy is national saving, which equals saving by the Federal71