via moneymetals
Some myths are stubbornly persistent. Count the greedflation myth among them.
A recent poll conducted by Navigator indicates a notable uptick in the number of people attributing inflation to corporate greed. That’s worrisome: public opinion eventually becomes public policy. Senators Warren, Casey, and Baldwin are again pushing for executive powers to “crack down” on what they see as “corporate price gouging.”
Despite its popularity, the greedflation narrative fails to hold up when subjected to standard economic analysis.
In brief, proponents of the greedflation narrative maintain that businesses deliberately hike prices in order to increase their profits.
Of course, if businesses increase their minimum willingness to accept (i.e., the supply schedule), the quantity demanded will fall. Hence, proponents of the greedflation narrative implicitly assume that higher prices will more than offset the revenue foregone as a consequence of selling fewer units.
Does this argument explain inflation? No. Standard economic theory demonstrates that there is a point where revenue maximization occurs — that is, a point where any further price increases would fail to offset the reduction in output, thereby resulting in less revenue. All else equal, profit-maximizing businesses will not increase prices further at that point.
Recall that inflation denotes a sustained and generalized increase in the overall price level. It requires more than just a few select prices to rise — and it requires that they continue to rise over time. At most, “corporate greed” may explain a high level of prices. It cannot explain why prices continue to rise over time. Price changes aren’t solely driven by changes in suppliers’ minimum willingness to accept.
Changes in demanders’ maximum willingness to pay (the demand schedule) also play a role. But consumers face a budget constraint: increased spending in one area implies reduced spending elsewhere. Some prices may rise, but others will fall. Changes in consumer demand may explain relative price changes, but cannot explain a sustained increase in the general price level.
For the general price level to rise, consumers must be able to increase their willingness to pay for goods in general. That occurs when the central bank injects excess money into the economy.
By fueling an overall increase in demand, central banks can generate a sustained increase in the general level of prices — inflation. Central banks are the primary source of money creation, not firms. Unlike greedflation, central bank behavior can explain high and persistent inflation. This explanation should be uncontroversial.
Milton Friedman famously said that inflation is fundamentally a monetary phenomenon, suggesting that its roots lie in the actions of monetary authorities rather than private producers.
Thomas Sargent echoed this sentiment, emphasizing the fiscal imbalances that can drive monetary policy astray.
Rather than focusing on the behavior of private firms, which remain subject to the immutable laws of supply and demand, proponents of greedflation would do well to scrutinize the decisions of policymakers. That’s where the real explanation can be found.