Do corporations take advantage of inflation with a “profit-price spiral”?
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Do corporations take advantage of inflation with a “profit-price spiral”?
This is just one of the stories from our “I’ve Always Wondered” series, where we tackle all of your questions about the world of business, no matter how big or small. Ever wondered if recycling is worth it? Or how store brands stack up against name brands? Check out more from the series here.
Listener and reader Alice Carli from Rochester, New York, asked this question earlier in the year:
We’ve been hearing lately about the wage-price spiral. Has anyone ever looked into the potential for a profit-price spiral? Where prices go up due to costs, supply, whatever reason, and manufacturers, distributors or platforms not only cover their costs, but make some amount of increased profit that then becomes a new profit “floor”? Do expectations of profit go up and down in a given sector — or just up?
Consumer prices started rising sharply in 2021, peaking at a 40-year high of 9.1% inflation in June 2022. This was caused by a slew of factors including pent-up demand due to the pandemic, supply chain constraints, and higher energy costs spurred by the Russia-Ukraine War.
Inflation has started to cool down in recent months and is now at 3%, but amid the thick of the battle to tame rising prices, the Federal Reserve had been concerned about rising wages.
The Fed wanted to prevent the economy from falling into a wage-price spiral, in which rising wages cause companies to hike prices, which then leads workers to ask for higher wages, creating an ongoing cycle. Now, thanks to a new paper from a regional Federal Reserve Bank, we’ve found that rising wages contributed little to inflation.
But what role do corporations play in all this? As Alice asked, are they taking advantage of inflation to pad their profit margins, thus setting a new standard for profits that will become ever higher and higher?
Alice’s question intersects with a heated debate happening in economics about a phenomenon that has been coined “greedflation,” in which corporations’ greed for higher profits is driving inflation.
Former U.S. Labor Secretary Robert Reich has blamed greedflation as the real culprit behind high prices.
“Corporations are using those increasing costs – of materials, components and labor – as excuses to increase their prices even higher, resulting in bigger profits,” he wrote in an op-ed for The Guardian.
Former Fed Vice Chair Lael Brainard, in a January speech, spoke of how increasing retail markups in different sectors are a sign of a “price-price spiral,” in which the final price tag has increased more than the costs to make it.
“Marketplace” spoke to some economists who say that corporations have been able to strengthen their profits, but only temporarily.
“Following the pandemic recession, profit rates did go up. It’s most likely because there was strong demand in the economy — an economy that was supply constrained,” explained Robert Triest, an economics professor at Northeastern University. “Firms were able to take advantage of that situation by raising their prices.”
Sometimes companies that are expecting future inflation will raise prices in anticipation of inflation so they can be ahead of the curve, Triest added.
But Triest said situations like these are not likely to develop into a price-profit spiral.
“In the longer run, firms are able to expand capacity and are able to raise their production and compete with each other,” Triest said. As a result, he added, that will help keep their profit margins in check.
New York University professor Chris Conlon and some colleagues actually set out to discover whether rising corporate profit margins are tied to rising prices. Their research found that between 2018 and 2022, there was zero correlation between companies with the highest markup growth and industries with the fastest price increases.
Conlon said that inflation is still higher than we’d like, yet corporate profits, in aggregate, have actually been on the decline for the past nine months or so.
“[Economists] typically think of profits not as a cause, but as an effect,” Conlon said. “It’s an output from demand and costs and things like that.”
Conlon noted that profits were indeed high in 2021. But between 2022 and 2023, while prices continued to grow, input costs rose more quickly, which is why profits are going down.
“It would be hard to increase profit margins indefinitely,” he explained.
While profits are going down, corporations still aim to make sure their profit margins are as high they can get away with, though.
“Companies would love to increase profit margins. They are always greedy in the sense they want to maximize profits,” explained Nick Bloom, an economics professor at Stanford University.
But Bloom noted that that doesn’t mean those profits will constantly rise.
“It is like an athlete who always tries to be fit — they are not getting continuously fitter, they just want to be as fit as possible at all times,” he said.
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