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Corporate profits are rising and inflation is high. So does one lead to the other? Is inflation caused by profiteering companies? Are we living through “greedflation”?
I say: no. Inflation isn’t driven by companies. And rising profits don’t mean the economy is uncompetitive.
Inflation is a macroeconomic phenomenon. That means it’s experienced by the whole economy simultaneously. It’s not possible for companies or industries to drive up prices for the economy as a whole.
But how come corporate profits are going up?
The starting assumption in any economic model is that companies are greedy. This is true at all times. They always want to charge as much as they can.
Companies are raising prices now because they can — because we’re in a situation of flux where everyone is raising prices. Everyone’s input costs are going up, and everyone’s expectations of what stuff should cost are a bit blurry. But that’s not the same thing as saying rising profits caused inflation. It’s the other way around — inflation caused rising profits.
You must ask — why did it take an outbreak of inflation for profits to rise? Profit margins weren’t rising a few years ago because companies weren’t able to get away with raising prices without losing market share. That’s the clue that shows competition keeps company profits in check. The reason companies are able to raise prices now because all other companies are raising prices, in a climate of higher costs and higher spending.
Here’s what I mean when I say no industry is capable of generating inflation. Imagine your income is €100 per day. You spend half of it, €50, on petrol. And you spend the the other €50 on groceries.
Now imagine the supermarket chains get together in a smoky room and agree to raise prices. Afterwards, groceries cost €75.
In this scenario the price of groceries will have gone up — but inflation will not. That’s because your daily income is still €100. If the price of groceries goes up to €75, you’ll have less to spend on petrol. The result is that inflation will stay the same. The only way to get a generalised increase in the price level — inflation — is for the amount of overall spending to increase.
It’s not plausible to say companies are rising prices because they’ve gotten more greedy. Companies are always greedy. When prices and margins go down, it’s not because companies get less greedy. And it’s not plausible to say companies have more market power now than they did a few years ago. Industries didn’t suddenly get more monopolistic.
The precise diagnosis of the problem matters because the cure for “greedflation” is very different to that for inflation. The cure for inflation is to reduce spending in the economy by having the government spend less on net, or by having the central bank tighten the money supply by raising interest rates. This is the diagnosis that won the argument in 1980 or so, resulting in 42 years of low stable inflation.
The solution to “greedflation” — as proposed by editorials in the Irish Examiner and the Business Post, former US Secretary of Labor Robert Reich, and SocGen bank analyst Albert Edwards — is price controls. Price controls are when the government makes it illegal to raise prices. They went out of fashion in the 1970s (except in Venezuela and Zimbabwe). They went out of fashion because they have a poor track record of controlling inflation where they were tried, and because they’re grossly inefficient.
Price controls are bad because they’re a supply-side solution to a demand-side problem. Under price controls, what happens when companies don’t raise prices when demand is surging? The companies sell out of goods. What happens when goods sell out? People queue to get their hands on them, and they start hoarding other goods for fear of getting caught out in future. So people end up paying for goods with their time rather than their money.
I’ll grant price controls can be useful in very specific circumstances. The time price controls have been effective is during the Second World War, when the government was redirecting as much production as possible to the war effort. Price controls in conjunction with rationing did their job — they helped beat fascism. But that’s not what we’re trying to do today.
If not greedflation, then what?
My contention is that there’s been an upsurge in demand (as opposed to an upsurge in greed). If that’s the problem, the solution is to reduce the total amount of spending in the economy. In theory there are two ways of doing this. The government can suck extra money out of the economy with taxes / or spending cuts. Or the central bank can suck money out of the economy by raising interest rates, which reduces the money supply.
Here in the eurozone, we rely in interest rates rather than government taxes and spending. This is out of necessity: we have a eurozone central bank but not a eurozone government.
The ECB has been accused of focusing on wages, rather than profits, as a driver of inflation. There is a good reason for this. Wages rise much more slowly than consumer prices or corporate profits. They’re hard to raise and they’re hard to lower back down. And high wages feed into consumer prices in a way that makes them much harder to suppress. Japan has had the opposite problem for 30 years — people are so accustomed to low wages that it’s hard to get employers to raise them, and hard for the central bank to raise prices and incomes.
I’m convinced excess spending is the problem, rather than excess greed, because total spending has been elevated far above its long-term trend since the middle of 2021. When total spending is growing faster than the economy’s ability to produce things, inflation is the inevitable consequence.
The following chart shows growth in nominal gross domestic product for the eurozone. It’s growth in total spending, without adjusting for inflation. As you can see at the most recent data in Q3 2022, it was running at more than twice the long-term average. The spike in spending was caused by rampant money printing after the pandemic, plus a moderate bump in government spending. It has nothing to do with greed.
As long as spending growth stays high, we're going to have inflation. As long as spending growth stays high, banning price rises won't solve the problem and will make things worse.
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