Spotlight - Greedflation – what is the evidence?

What is greedflation?

Since the start of 2023, a new factor has come under scrutiny to explain the inflation surge: the contribution from rising corporate profit margins, or in more popular parlance, greedflation. As with households over the past 2 years, firms have faced higher input costs, be it energy or higher costs for raw materials. As a consequence they have passed these price rises on to customers. According to the greedflation hypothesis, firms have opportunistically raised prices by more than can be justified by rising input costs alone.

Is there evidence of greedflation?

At the aggregate level there is indeed evidence of increased profits contributing to inflation in advanced economies. The ECB and the OECD have concluded so by decomposing the GDP deflator; the price change of domestically produced goods and services, which is a measure of domestically generated inflation. When breaking down the deflator between profits, wages and taxes two conclusions arise: 1) wages and profits have contributed increasingly to inflation, and this trend has strengthened (in the eurozone) since the end of 2021; 2) profits have become a bigger driver than wages since H2 2022.

What could explain the above? Since the pandemic we have seen a strong but unbalanced economic recovery. Demand has outstripped supply in a number of sectors. The prime example of this is the strong demand for services since lockdowns were wound down, where supply in those sectors could not keep up. Strong demand and constrained supply generally gives firms the opportunity to raise prices. And this behaviour can quickly spread in an inflationary environment, because the opportunity cost (often referred to as menu costs) of raising the price of a particular product is lower when other prices are being raised. Lastly, inflation creates a situation of information asymmetry between firms and customers, where the latter do not know which price rises are due to rising input costs and which are due to margin expansion.

Although rising profits have clearly contributed to inflation, we would caution against interpreting this as a broadbased greedflation, for a few reasons. First, these conclusions are based on aggregates. While official data is lacking at the sector level, previous work we have done looking at publicly listed company filings suggests margin expansion is concentrated in a few sectors. Similarly, the OECD research shows differences between countries, and methodological issues also cloud the picture: in countries with a large share of sole proprietors such as the Netherlands, the profits of this group resemble (at least partly) wage income. And lastly, profits show more volatility over time than wage costs. It remains to be seen if the current increase in profits is structural, or rather in anticipation of rising wage (and other) costs down the line.

Why does it matter?

For the trajectory of inflation it is important to know the drivers of inflation. The rising contributions of wages and profits to inflation depict an environment where firms and workers seek to minimise their real income losses by shifting the burden of higher input prices onto the other party. This is the tit-for-tat dynamic ECB President Lagarde has warned of, which could result in a wage-price spiral (or rather a profit-price spiral) where inflation settles at a higher level for longer. Ultimately, greedflation is a distributional question of how the burden of (among other price rises) higher energy costs are shared between businesses and workers. This distribution will depend on bargaining between workers, businesses and the government. But judging from the warning of Ms Lagarde, central banks are also monitoring the possible resulting negative wage-price or profit-price spiral closely.

This article is part of the Global Monthly of 26 June 2023