The “corporate greed” theory of inflation
Since the world emerged from the COVID shutdowns in 2020, developed economies — including the United States — have been experiencing high inflation.
Currently, the inflation rate sits at 6.4% in the United States, and is even larger for staple items like food (10.1%) and energy (8.7%). Prices of everything are soaring.
That leads to a lot of posturing as to what caused inflation.
A popular trope is that corporate greed is the cause, not just in the U.S. but in other developed countries, citing rising business profits as the evidence.
There are a lot of problems with the “theory” of greedflation. First, it assumes firms have the power to set prices, as if they get together in a smoky room and say “hey, let’s jack prices up on our customers.” But that assumes a level of coordination that’s largely impossible, and a level of power that firms have to unilaterally set prices. Competitive firms are looking for an edge, and especially in goods with high elasticities, the one with the lowest price is going to get the sale. Walmart doesn’t make millions because it jacks prices up, but because it sells goods for the lowest possible price and makes small profits on a high volume of goods. Every fast food chain has some kind of value menu because of the same level of competition.
It’s based on a belief firms engage in a “cost-plus” model of pricing. Essentially, if a good costs “X” to produce, we’ll add in “Y” profit margin for each good and sell it to the consumer. If we just decide we want more profit, we’ll just add “Y” and, voila, consumers will pay it because they have no other choice.
That theory ignores the other half of the equation — the consumer. If prices are too high, consumers simply will buy less of a good or switch to substitutes and not buy it at all, thus not leading to “greater profits” but less. Also, if consumers have to pay more for one item, they will necessarily have to cut back in other areas, thus lessening the demand for those goods, which would drop the price.
Pricing is not determined by “cost-plus,” but by markets — supply and demand.
As Milton Friedman has said, “inflation is always and everywhere a monetary phenomenon.”
Inflation isn’t caused by “corporate greed.” It’s caused by an increase in the money supply. From January 2020 through April 2022, the M2 money supply rose 42.7% in the United States as the Federal Reserve overreacted to pandemic shutdowns by flooding the economy with money via low interest rates and financing deficit spending, stimulus checks, bailouts and more. Central banks around the world did so The CPI has risen 17.5% in roughly that same time frame. Anyone who was paying attention in mid-2020 could have accurately predicted persistent high inflation because of the increase in the money supply, and that’s what the U.S. and most developed economies are experiencing now.
When you flood the economy with money, consumers and investors now have more cash. They have two options — save it or spend it. “Saving” usually goes into assets such as stocks and bonds, and the initial flood of money supply went into the market in 2020. But as it filters into the economy, consumers now have more cash to spend, which they spend buying goods and services.
The thing to understand about markets is buyers and sellers do not compete with each other. They engage in a cooperative, mutually-beneficial relationship. Sellers compete against each other to find buyers, and buyers compete against each other to purchase goods. When goods are abundant, sellers have to work harder to find buyers, which drives prices down. However, when there are shortages, buyers compete against each other and outbid each other for the goods that exist, thus driving up the price. Sellers do not have to work to find buyers. As a result, firms in a tight market will make greater profits as they find buyers willing to pay higher and higher prices. Buyers are willing to do so because they have more money due to the expansion of the money supply.
Prices are not arbitrary numbers developed by people colluding on how many numbers to put on a menu or store shelf. They are, instead, the result of the interactions of buyers and sellers and frequently adjust. Yes, increased costs for a firm do often cause prices to rise, because higher costs shift the supply curve left, which reduces the supply of goods and thus forces prices up. But increased demand also causes prices to rise. In both cases, goods are significantly more scarce, meaning buyers have to search harder to find sellers and are often willing to pay a premium.
Prices are also signals that contain and confer information that no planner nor government official is capable of knowing. A high price signals to firms to produce more of a good, while simultaneously signaling to buyers to purchase less. In the long run, that relieves shortages and moderates prices. A low price signals to firms to produce less, and for buyers to purchase more, clearing surpluses and again moderating prices. The miracle of the market allows consumers to tell firms what to produce, and for firms to satisfy consumer demands.
When governments intervene by flooding the market with money, then complaining about the inevitable rise in prices due to such flooding, they’re not only harmfully manipulating the market, they’re being disingenuous.
The current run of inflation was not caused by “greed” and it will not be solved through diktats and price controls. It can only be solved through sensible monetary policy — which means the Fed needs to stop manipulating interest rates to try to “jump-start” the economy and use a fixed monetary standard.
When it comes to inflation, it’s never “greed.” It’s always the central bank.