Replacement versus Historical Cost Profit Rates: What is the difference? When does it matter?

This paper explains the BEA methodology for computing historical cost and replacement cost measures of the net stock of capital in the U.S. economy. It is demonstrated that there exists a threshold rate of inflation in the price of capital goods that keeps the percentage difference between the two capital stock measures constant. Hence, over periods when average inflation in the price index for capital goods is equal to the threshold value, historical cost and replacement cost profit rates would show equal percentage changes; an example of such a period for the U.S economy is the whole postwar period 1946-2010. Moreover, trends in both replacement cost and historical cost profit rates display very similar movements over long periods, making the choice of capital stock valuation irrelevant for empirical analysis of profitability trends. JEL Categories: E01, B51