What has been driving inflation? Economists' thinking may have changed : Planet Money Economists say that inflation is just too much money chasing too few goods.

But something else can make inflation stick around.

If you think of the 1970s, the last time the U.S. had really high sustained inflation, a big concern was rising wages. Prices for goods and services were high. Workers expected prices to be even higher next year, so they asked for pay raises to keep up. But then companies had to raise their prices more. And then workers asked for raises again. This the so-called wage-price spiral.

So when prices started getting high again in 2021, economists and the U.S. Federal Reserve again worried that wage increases would become a big problem. But, it seems like the wage-price spiral hasn't happened. In fact wages, on average, have not kept up with inflation.

There are now concerns about a totally different kind of spiral: a profit-price spiral. On today's show, why some economists are looking at inflation in a new light.

This episode was produced by Sam Yellowhorse Kesler and engineered by Katherine Silva, with help from Josh Newell. It was fact-checked by Sierra Juarez and edited by Jess Jiang.

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What has been driving inflation? Economists' thinking may have changed

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Inflation for a lot of us might just feel like prices going up on us, right? But there is something that, like, kicks off inflation, that gets the inflation train going. Economists say it is too much demand chasing too little supply - too much money, not enough things to buy.


But something else can make inflation stick around. If you think of the 1970s, which was the last time the United States had really high sustained inflation, a big concern was rising wages.

GONZALEZ: Yeah, prices for goods and services were high, and workers, maybe expecting prices to be even higher next year, asked for pay raises to, like, keep up. But then companies had to just raise their prices more to cover the new labor costs. And then workers asked for raises again, and it all, like, spiraled out of control.

ROSALSKY: Which is why it is appropriately called the wage-price spiral.

GONZALEZ: It's a pretty good name.

ROSALSKY: Pretty darn good name.

GONZALEZ: (Laughter).

ROSALSKY: And when inflation started getting bad in 2021, economists in the U.S. Federal Reserve worried that wage increases would be a big problem.

GONZALEZ: There was the same concern in Europe - in Germany, the U.K. The head of the U.K. central bank actually said last year that workers should restrain themselves from asking for big wage increases because inflation could get, quote, "out of control." But it seems like a 1970s-style wage-price spiral hasn't happened - not in Europe, not in the U.S.

ROSALSKY: Janet Yellen, the U.S. treasury secretary, just said this year that a wage-price spiral is, quote, "not happening." In fact, wages on average haven't really been keeping up with inflation, at least until recently.

GONZALEZ: So if wages haven't been the big problem, what has been keeping inflation going?


GONZALEZ: Hello, and welcome to PLANET MONEY. I'm Sarah Gonzalez.

ROSALSKY: And I'm Greg Rosalsky. In the past, we've kind of blamed workers for inflation, for creating the wage-price spiral by asking for raises.

GONZALEZ: But there are now also concerns among economists and central bankers about a totally different kind of spiral, a profit-price spiral.

ROSALSKY: Today in the show, we are looking at inflation a little differently now.

GONZALEZ: And more eyes are on corporations, at least in some corners of economics.

OK. Will you say your name and title for us?

ISABELLA WEBER: OK. Isabella Weber, professor of economics at the University of Massachusetts, Amherst.

GONZALEZ: Isabella is how I should say your first name?

WEBER: Yeah. I mean, I'm German, so it's a Spanish name. I don't know how to pronounce it anymore, to be honest (laughter).

ROSALSKY: We talked to Isabella because she's kind of at the center of this debate about what's been driving inflation.

GONZALEZ: Isabella's background is in inflation during times of economic transitions, like after World War II.

WEBER: Yeah, so inflation in times of structural breaks and pretty fundamental processes of change. So I had studied the transition from a war to a post-war economy.

GONZALEZ: And Isabella says there is a formula for what causes inflation. And it's very simple. It's costs plus corporate profits. That's how you get inflation.

ROSALSKY: Costs are wages - right? - you know, like, labor and what you have to spend on, like, raw materials and energy. And corporate profits are, well, you know, profit. I mean, it's the money that companies make after covering their costs.

GONZALEZ: So if labor costs increase 'cause you have to pay workers more, you can get inflation. If corporate profits go up, you can get inflation. But in most of our lifetimes, corporate profits have never appeared to play, like, any big role in this equation. So when corporations started making a ton of profits during the pandemic - like, record profits - all of these economists were kind of like, yeah, that's OK. It's not a problem. Corporations can make however much money they can get out of us. It's not, like, driving inflation or anything.


UNIDENTIFIED PERSON #1: Corporations always tried to raise prices whenever they could.

UNIDENTIFIED PERSON #2: Did the profit maximizing behavior of firms suddenly take a jump up in 2021? I don't have any evidence that that's the case.

UNIDENTIFIED PERSON #3: I don't think inflation has anything much to do with gouging.

UNIDENTIFIED PERSON #4: Blaming inflation on greed is like blaming a plane crash on gravity.

ROSALSKY: This greed or greed-flation (ph) argument was dismissed pretty definitively by most economists, including Isabella.

WEBER: Firms have always been greedy, right? I mean, firms always want to pursue profits. That's what firms do. So I don't think that there has been a sudden increase in corporate greed. But the question is, when is a situation when they can hike prices, and when is a situation where they cannot hike prices?

ROSALSKY: Isabella says some of the economic forces that normally keep prices and profits in check can break down a little bit sometimes, like when there are really severe bottlenecks like the kind we had after World War II.

WEBER: When firms had to retool from producing tanks to producing cars, from producing guns to producing refrigerators and so on, so that you also had pretty severe bottlenecks - and in that kind of situation, firms reacted by increasing price in ways that increased their profits. So I had been studying that case.

GONZALEZ: Isabella says really severe bottlenecks present opportunities for corporations to hike prices in ways that they can't hike prices in normal times, because in normal times there's a fear that raising your prices can make you lose customers. But when there are bottlenecks and shortages, Isabella says that that competitive pressure, the fear of losing customers becomes weaker because she says consumers expect prices to be higher in moments like this, so corporations can profit more.

WEBER: So if you look in the data for profit margins, then the last time the profit margins shot up was in '46, '47, right after the war.

ROSALSKY: So in 2020, when the pandemic started and there were all of these supply chain issues because factories had shut down and people all of a sudden wanted to buy more stuff and there were those big shortages, Isabella was like, I think I know how this story is going to turn out.

WEBER: Already in 2020, we were starting to see first bottlenecks, right? And I was like, oh, my God, this is kind of the same situation as the one that we were in right after the war, and I was kind of waiting for that thing to happen. I was waiting for prices to go up and profits to go up, so I wasn't surprised when inflation hit in 2021.

GONZALEZ: If you remember, the leading theory was that this episode of inflation was going to be transitory - right? - that it would all go away once the supply chain issues sorted themselves out. But Isabella was like, I'm not so sure.

WEBER: I was like, OK, now it's time for me to step in.

ROSALSKY: She writes an op-ed in December of 2021.

WEBER: So I started the article off by saying there is an overlooked component in inflation, which is an explosion in corporate profit margins.

GONZALEZ: And in this article, Isabella pointed out that mainstream and conservative economists after World War II all wrote a letter to the editor of The New York Times once in 1946 warning that really severe bottlenecks are a big problem for trying to contain inflation.

WEBER: The most prominent, most reputable representatives of the economics profession, people like Paul Samuelson.

ROSALSKY: Oh, Paul Samuelson. Who could forget him? He probably wrote the most popular economics textbook.

WEBER: Irving Fisher, who was an extremely conservative monetary theorist.

ROSALSKY: Oh, Irving Fisher. Who could forget?


WEBER: At the time, they were arguing that in the areas where you have very severe bottlenecks, you would need strategic, carefully selected price controls in order to prevent firms from hiking prices. My point was to say that this was what economists, when they were studying this kind of problem in a very active way, that this is what they came up with. And the reaction was pretty brutal.

GONZALEZ: Pretty brutal?

WEBER: Yeah.

GONZALEZ: What happened?

WEBER: Well, it was picked up on Twitter, and economists, including some very famous economists, thought that it was entirely absurd. I was being called names. I was being shamed for not being a real economist and an exam question of the University of Chicago. And I was basically called crazy for saying what I was saying.

ROSALSKY: People were mainly upset that she was saying we should consider imposing strategic price controls like the United States used to do back in the day, in other words, putting a cap on how much corporations can charge for some very selective things, which is a big no-no in most economic corners, because generally speaking, they believe price controls distort the economy and create shortages. Think the huge lines for gas stations in the 1970s after President Nixon put in some price controls.

GONZALEZ: Yeah. So the price-control stuff was the big, big headline. But Isabella says people were actually equally annoyed with her for suggesting that corporate profits play a role in inflation. But Isabella and other economists way before her have kind of been like, I mean, of course, corporate profits can be a driver of inflation. It's right there in the inflation formula. Inflation is a rise in costs, like wages, plus a rise in profits.

WEBER: There is no reason why we could only have an inflation that is driven by wages. We could equally have an inflation that is driven by profits.

GONZALEZ: We should say here that Isabella has a reputation for being an...

WEBER: An unorthodox thinker.

GONZALEZ: An unorthodox thinker. But recently a few people have joked to Isabella that she might be losing her reputation as an unorthodox thinker, because now more and more studies and more and more economists are saying, maybe we should start looking more at the profit side of the formula. I think it can tell us a few things.

WEBER: So, yeah, I think the discourse has shifted, but we haven't quite landed on a final conclusion yet.


ROSALSKY: That's after the break.


GONZALEZ: When economists started debating what was driving inflation in 2021, there wasn't a lot of data. There were pieces of data, but not, like, the full picture, right? Now we have more data. And an economist at the Federal Reserve Bank of Kansas City decided to start poking at it.

So you're an economist at the Fed?


GONZALEZ: Kind of fancy.


GLOVER: I guess. But it's Kansas City, so it's a less fancy city.


Andrew Glover at the not-quite-fancy Kansas City Fed decided to look at how much costs went up for corporations and how much their profits went up because then you can assign how much cost contributed to inflation and how much profits contributed.

GLOVER: Remember, this is a useful exercise to remember the formula. Inflation is cost growth plus growth in the markup that you're charging.

ROSALSKY: So Andrew has done a couple of studies that looks at basically every type of good or service sold in the United States.

GONZALEZ: You're talking about, like, socks and shirts and ketchup and Delta Air Lines tickets.

GLOVER: Exactly. So, you know, McDonald's would be in here. Walmart would be in here. Ford would be in here.

GONZALEZ: Pepsi...


GONZALEZ: ...Coca-Cola...


GONZALEZ: ...Whatever.

GLOVER: Yes. Yes.

ROSALSKY: Andrew's looking at all of their markups.

GLOVER: So the markup is the price that the firm charges its customers above and beyond the costs that it incurs from producing the good that it sells them.

GONZALEZ: Meaning, like, it cost me $3 to make these socks, but I'm going to sell them for $4.

GLOVER: Sure. So - yes.

GONZALEZ: That $1 difference is the markup?

GLOVER: Yeah, the $1 difference is the markup that you're charging.

GONZALEZ: The markup is their profit. And it's not like corporations can just charge whatever they want for socks just to make a ton in profit. Without consumers maybe knowing it, we kind of prevent companies from getting whatever they want in profits. Because if prices get too high, we go to a different, cheaper sock-maker, or we at least buy fewer socks.

GLOVER: If you charge too high of a price, you make more on each unit you sell, but you can sell so few units that your profits fall.

GONZALEZ: So then, corporations are trying to find, like, the sweet spot. Like, what is the perfect price that will allow me to sell as many socks as possible so that I get more profit?

GLOVER: Yeah, if you can think about, like, balancing a seesaw.

GONZALEZ: But some economists, like Isabella in particular, say that when there are bottlenecks, the seesaw gets, like, a little tilted because companies think, OK, my competitor is raising prices because they actually are experiencing supply chain issues. I'm not, but no one will really know that, so I'm just going to raise my prices, too.

ROSALSKY: And when we, the consumers, hear of bottlenecks, we may tolerate higher prices than normal because we're like, yep, my favorite sock people can't get the cotton they need because of all those supply chain issues.

GONZALEZ: It's a supply chains issue. Yep.

ROSALSKY: It's not their fault.

GONZALEZ: Andrew's study does not back up this theory, but it does say something pretty major about the role of corporate profits.

Will you read for me - it's on the second page, I believe - the sentence that starts, we find evidence.

GLOVER: (Whispering) We find evidence, second page.

GONZALEZ: Andrew whispers to himself a lot.

GLOVER: One second.

GONZALEZ: Mmm-hmm.


(Reading) We find evidence that markup growth was a major contributor to inflation in 2021.

GONZALEZ: And keep going.

GLOVER: (Reading) Specifically, markups grew by...

GONZALEZ: Specifically, the report said, corporate profit growth could account for more than half of 2021 inflation.

GLOVER: (Reading) Could account for more than half of 2021 inflation.

ROSALSKY: Corporate profit growth accounted for nearly 60% of inflation, to be more precise. Normally, Andrew says, it contributes less than a third. So this is about double.

GONZALEZ: And this is kind of like - I don't know. This is a big finding, right?

GLOVER: Yes. I mean, I think one of the things that we've discovered is that it may not have been as atypical as in - just in any given normal year.

GONZALEZ: Yeah, it sounds bad, but Andrew says this isn't actually that unusual. Andrew found that historically, corporate profit growth has always been a driver of inflation in the year following a recession, which - remember - we did have in 2020.

GLOVER: Yes, we see it in 2009. We see it in 2002, 1976. We see it in many years following a recession.

GONZALEZ: Andrew thinks it's probably just that no one really looked at the profit side of things before because in the past, inflation has been low. So no one really cared how much corporate profits contributed to almost no inflation.

ROSALSKY: So, OK. Andrew is saying prices did not go up because costs went up. He's saying corporations pocketed more. They raked in more profits.

GONZALEZ: And you might think, well, it's probably just that there was more demand for things, right? Like, when there is more demand, corporations can get more out of us. They can charge more 'cause we really want that canoe right now. But Andrew found that across industries that experienced very different levels of demand, profits went up. So even in areas that had lower demand, profits went up.

GLOVER: When we looked at the markup growth, they were very similar. Firms in sectors that have very different demand are still marking up their prices at similar rates.

ROSALSKY: Andrew does not think this is proof companies were just using inflation as an excuse to, like, gouge consumers or something.

GONZALEZ: He thinks companies likely raise their prices not because their costs went up in 2021 - because they did not really - but because they were anticipating that their costs would go up a lot in 2022.

ROSALSKY: He suspects companies were all getting similar signals, like, from their suppliers or something that, like, some future order would cost more. And we should say, their costs did end up going up a year later, in 2022. But companies still made record profits that year despite those higher costs.

GONZALEZ: So, OK. Corporations anticipated higher costs, so they raised their prices. And they raised them so much that they made way more profit than what their costs actually were to the point that they were making record profits, a lot of corporations. So they overanticipated how much costs would go up.

ROSALSKY: (Inaudible).

GONZALEZ: More whispering.

Like, isn't that why their profit is so much more than their cost because they, like, overshot it?

GLOVER: How to see it...

GONZALEZ: Andrew is very careful about how he says things.

GLOVER: What is fair to say is that it is possible that firms, by anticipating higher costs, contributed to the inflationary pressures that actually led to higher costs.

ROSALSKY: Yeah, corporations anticipating higher inflation could be the reason why we got higher inflation.

GONZALEZ: And for Andrew, this is a really interesting finding because for decades, economists have looked at wage growth as the big, main indicator of whether more inflation was coming. Andrew is saying maybe we should now look at rising profits as an indicator, too.

GLOVER: This might become a useful, new metric to look at when we think about, well, how persistent could these inflationary pressures be?

ROSALSKY: OK. So let's just pause for a second on this idea that costs don't even need to go up for corporations. Just worrying that their costs could go up in the future could drive inflation.

GONZALEZ: Andrew says this is why setting expectations around inflation is so important.

GLOVER: If we were to get in a situation where not only in 2021 that firms expect higher inflation, but in 2022, they expected it, 2023, they expected it, and they just kept expecting higher and higher inflation, then we very well could end up in a world where profits are always rising in anticipation and are always a major contributing force to inflation. And so, you know, one of the goals that we have are to keep inflation expectations anchored around our target of 2%. And certainly, one of the outcomes of that would be that we don't see a profit price spiral.

GONZALEZ: A profit price spiral.

ROSALSKY: (Imitating spiraling wind).


ROSALSKY: So not a wage price spiral, but a profit price spiral or a price price spiral.

GONZALEZ: A price price spiral is when corporations raise prices by more than the increase in their costs. And here's how Andrew says things could spiral out of control. Let's say a corporation, like a tiremaker, expects costs to go up. So they raise prices in order to keep the same profits that they used to have, right? But then, the next corporation, like a carmaker, is like, OK, well, I have to buy tires, so I'm going to raise my prices, too, so that my profits don't drop. And it all spirals like that.

ROSALSKY: The price price spiral is a new phrase. I mean, this is the hottest thing in town, people, the price price spiral.

GONZALEZ: (Laughter).

ROSALSKY: It was coined in January by an economist named Lael Brainard. And let me tell you, this thing is catching on, people.

GONZALEZ: Paul Krugman, a pretty mainstream economist, just said that if anything, we have seen something like a price price spiral. And outside of the U.S., more and more attention is on the price side of things. The head of the U.K. central bank, who, a year ago, was asking workers not to ask for big wage increases, recently started asking companies not to raise prices. And now we're seeing central banks in Europe, in the U.K., sort of shifting and saying, no, no, no, corporations. Corporations, please lower your prices. We really expect inflation to drop sharply this year. Just please, please, please don't raise your prices more because that's contributing to inflation. So it feels like the focus has shifted on the wage earners to the corporations.

GLOVER: Right. And in some ways, you know, I think asking nicely, in the same way that asking workers not to request higher wages, is - I don't know that many people would listen if I told you, don't ask for a higher wage. I don't know that just asking is really - is going to be very effective.

ROSALSKY: Central bankers in Europe also apparently don't think that just asking nicely will work either, which is why they're also raising interest rates like we are in the United States.

GONZALEZ: And the way raising interest rates works is it basically makes people have less money to buy things with because it's harder to borrow money. And if people have less money to buy things with, that will hopefully make corporations finally bring down their prices again so that we can buy again.

ROSALSKY: But economists like Isabella are like, why is raising interest rates, like, the only tool the United States considers?

WEBER: Which is basically a recipe of making the majority of people even poorer.

GONZALEZ: Isabella is like, why do the workers have to be the ones to get screwed? They weren't even the problem this time.

ROSALSKY: She argues for fighting inflation without inflicting all this collateral damage on the economy. She proposes a windfall profit tax - basically taxing corporations if they, all of a sudden, get a windfall of profits.

GONZALEZ: Of course, a lot of disagreement among economists about this. But however economists feel about the best way to fight inflation, many are now open to the idea that corporate profits are an important part of the equation. Isabella recently released a paper calling this era of inflation a seller's inflation, and she's been surprised with the reaction she's gotten this time around.

WEBER: Some prominent economists have, I would say, shifted from seeing this as some sort of voodoo economics to seeing it as a possibly plausible explanation.

GONZALEZ: A possibly plausible explanation? So they're not quite like, oh, yes, this is it. They're just like, maybe, maybe. I'm not a hundred percent out on it.

WEBER: That's the feeling that I have, that we are kind of at this tipping point. I mean, we have much more evidence in hand.

GONZALEZ: Do you feel a little bit vindicated?

WEBER: I do feel vindicated. Yes.

ROSALSKY: Both Isabella and Andrew say it will be interesting to see what corporations do this year. On earnings calls, some CEOs have been saying they plan to keep prices high even though they don't anticipate costs going up anymore basically because we've shown that we're willing to pay these higher prices.

GONZALEZ: And we should say that keeping prices high would not cause inflation to go up. They would have to raise prices more to increase inflation. If we want corporations to cut prices - I don't know - maybe we just buy less, stop accepting the higher prices. If we stop buying things, that could get corporations to lower prices.


ROSALSKY: Today's show was produced by Sam Yellowhorse Kesler and engineered by Katherine Silva with help from Josh Newell.

GONZALEZ: It was fact-checked by Sierra Juarez and edited by Jess Jiang. Special thanks to economist Hal Singer. I am Sarah Gonzalez.

ROSALSKY: And I'm Greg Rosalsky. This is NPR. Thanks for listening.


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