Global Econ Q&A: Blaming Businesses For Inflation

I started this column, or newsletter (whatever you want to call it), with a piece entitled “Who’s To Blame for Inflation: An Answer in Two Pictures”. In that I showed that both government spending and the money supply exploded in the USA in 2021 and 2022. Those are the primary causes of inflation today, in my opinion.

Already I had some comments and questions.  That inspired me to attempt a series where I try to answer questions people have.  Please send me any suggestion for what to call this series. I thought “Ask the Professor” or “Ask the Global Economist”, but maybe it’s just “Global Econ Q&A”. … I’m open to suggestions.

The first question that arose was more or less this: “What about businesses?  Don’t you think they should get some of the blame for inflation?”

The short answer is “no”.  The longer answer follows below. 

From an analytical point of view, the first question I ask is: what changed?  We had been experiencing about 2% or less inflation for many years.  We only had inflation over 5% twice since the 1980s and both times it was short lived, immediately falling the month or two after the peak. The first time was in October 1990 (6.4% inflation) and the second time was in July 2008 (5.5% inflation).  But these were blips in a sea of otherwise tranquil inflation. From January 1990 to December 2019, inflation averaged 2.5% a year.

When we see something dramatically change at the macro level in an economy the size of the US’s, we have to look for big changes that caused it.  And nothing big changed with businesses.

Whether you believe businesses and business leaders are greedy or not, they didn’t suddenly get overcome with massive greed and drive up all the prices. Energy companies didn’t suddenly become greedy and drive up gas prices.  Food company execs and restauranteurs didn’t suddenly become possessed and decide to drive up their prices too.

As an economist, if you can point to a major change in tax codes or regulations, then maybe we’d see a change in pricing in the sector affected.  The “Trump tariffs” had a small effect a few years ago, but those can’t be driving sudden inflation today.

Covid was a big enough shock that it is still causing labor shortages and strange supply chain problems. So that could be a cause worth considering.  My personal view is that maybe half of the “inflation challenges” we see today are due to Covid and supply chain issues.  And untangling that from the effect of monetary and fiscal policy is a valid investigation.  It’s one I’ll be exploring.

But the greed of humanity didn’t suddenly change.  And even if it had, competition would prevent those price increases. If you are in business and your competitor is dumb enough to decide to double their prices, let them! Just let them double prices, then wait for all their customers to come flooding over to you. 

And to that point, nothing changed – to the best of my knowledge – around the nature and degree of competition in most markets either.  Sure a few stores, restaurants and businesses closed.  But the same big energy companies are processing oil and gas today that were doing it two or five years ago. The same is true for our major food producers, grocery stores, car makers, etc.

Analytically, then, I see no possible way to blame businesses per se for the higher prices we see today. Nothing changes dramatically in a short period of time.

One implication behind the question is that if businesses weren’t greedy, then maybe they wouldn’t raise prices as much.  Let me address that, because you hear it a lot today.

First of all, as I just argued, if a business wanted to be greedy, it would undercut its competitors and try to attract their competitors’ customers away from them.  The beauty of a competitive market system is exactly that you can only get rich in a market by serving others. Provide them what they want at prices they can afford and you can earn a lot of money.  Provide them things they don’t want at prices they can’t afford and you’ll sell nothing.  When there’s competition, then prices get driven down as greedy business people compete to serve more customers and serve them better with lower prices and better products. 

That’s the old “Invisible Hand”.  It doesn’t work perfectly, but it does work generally. It’s the reason laptops are better and better but relatively the same price, phones improve dramatically and cost about the same while other products have similar quality and just get relatively cheaper. The result is that pretty much all products either have the same quality and lower prices over time or the same prices and better quality over time.  The places in an economy where that is not true are always the places lacking market competition.

Second, we saw businesses doing just that – trying not to raise prices. They actually tried everything they could not to raise prices during the pandemic, perhaps in a hope that rising prices would be a temporary phenomenon.  We all certainly – and wrongly – thought the pandemic would be shorter lived than it was.

In any case, we saw businesses try to fight the higher price wave. As an example you might have directly noticed: restaurants made burgers a bit smaller, put a few less fries on the plate and so on to avoid raising prices much.  Most businesses did something similar. 

But there comes a point where the costs of materials and wages are rising so much that business can no longer hold their output prices down.  And that is the flood gate that seems to have just broken in the USA – and subsequently around the world – and the reason for the sudden inflation panic.

Covid was a huge shock to the US economy and to every economy in the world. It had huge negative personal, health and economy effects.  Governments tried to help offset that damage with massive spending packages that were mostly financed by printing money.  That flood of spending and extra money has led to inflation.  We can debate whether it was a good or bad idea, but that is quite clearly the cause of the inflation we are seeing today.

Now I do believe the Federal Reserve (FED), of all the government’s agencies, should have understood and expected this inflationary effect.  In my opinion, the FED should have slowed the growth of the money supply sooner and begun slowly raising interest rates, probably last summer (2021) at the latest.  Also, in my opinion, the argument for the second stimulus package in 2021 was much less convincing.  But again, seeing that pass in 2021, the FED should have known inflation would surely follow and begun to act accordingly.

The FED is the only agency of the government with what is know as “the dual mandate” to (1) maintain price stability and (2) maintain employment.  In all likelihood, over the long run, the FED can actually only achieve #1, price stability.  And it has not done that very well lately.

Blaming businesses is a red herring, distracting us from focusing on the fiscal and monetary policy at the heart of inflation.