The 2022-23 Economic Crisis Megathread

[DGuller]

It just seems like short hand by people who aren't necessarily financially "literate". It's not the correct terminology, but isn't wrong in the sense that there's no correlation.

It's not a short hand, I'm not trying to be pedantic.  I just have no idea what even the logic is, with or without terms. 

In a free market, companies do not truly have the power to dictate how much profit they're going to make.  Yes, they make a lot of decisions, but competitive pressures pretty much guide them to what those decisions are.  When you're driving to work, technically every turn you make is your decision, but in reality your decisions are railroaded by the necessity to get to work in a reasonable amount of time.  You may feel like you're in control, but in reality it's the geography of the roads and the traffic conditions that dictate what turns you take.

[Sheilbh]

Inflation is a measure of the change of prices of goods and services.  Profit is not the price of anything, neither is it a good or service.  People don't go to the shop and buy a sixer of profit.  Or complain that a bunch of bananas used to cost 3 profits but now cost 6.

Sure.

In a context where there has been real economic flux, real demand and supply shocks - if you were an opportunistic company, then you could increase prices by more than just covers the increase in input costs. The ECB has noted that half of domestic price pressures in the Eurozone appear to be coming from unit profits (the other half, roughly is labour costs).

If the market your company in is generally doing that then you either have the choice of increasing margins and sticking with the pack, or making a play for market share (and explaining to investors why your competitors have record margins). There are big variances by sector but they include sectors like agriculture and there are some sectors where it looks like, market-wide, prices were increased that more than covered covered their costs. That then flows further down the chain. From the ECB on changes from 2019 to 2022:


It has been suggested that there are companies exploiting uncertainty and a crisis moment with high and volatile inflation, to increase prices beyond what would absorb costs and in effect creating a "price-price spiral" that could make core inflation "stickier". As wage increases seem to have peaked (and have not matched inflation) but profit margins have increased in certain sectors that also raises the question of the role opportunistic price rises to improve your margin is playing.

It just seems like short hand by people who aren't necessarily financially "literate". It's not the correct terminology, but isn't wrong in the sense that there's no correlation.

You've had vice-chairs and Presidents/Govenors of the Fed, ECB and BofE raise the issue of profits over the last few months and talking about the risk of a "price-price spiral". The point is wage increases, or the share going to labour, can increase without raising inflation simply by seeing a - to quote an ECB exec - "normalisation of profits".

I'd also think in a way it's easier to deal - you can have windfall taxes on sectors or companies that are opportunistically increasing their margins in a moment of crisis. As I say I think in certain sectors it's borderline profiteering (and all governments have taken measures against profiteering in times of war) - taking advantage of a pandemic and war with all their economic impact to raise prices far beyond what would cover their costs, and instead have recorded profit margins (in certain sectors).

From what I understand these are generally in upstream and fairly concentrated sectors - agriculture, energy, utilities, shipping - and that has economy wide impacts especially if markets downstream have similar-ish factors because they could then be increasing that effect.

[Admiral Yi]

Do you have a link to that report?

[Sheilbh]

NYT article on it:
https://www.nytimes.com/2023/03/31/business/company-profit-inflation-europe.html

Are Big Profits Keeping Prices High? Some Central Bankers Are Concerned.
Companies' rising profit margins could be contributing to persistent inflation, a European Central Bank policymaker says.
By Eshe Nelson
March 31, 2023

After months of fretting about whether workers' rising pay would keep inflation uncomfortably high, central bankers in Europe have another concern: large company profits.

Companies that push up their prices above and beyond what is necessary to absorb higher costs could be fueling inflation that central bankers need to combat with higher interest rates, a policymaker at the European Central Bank warned, suggesting that governments might need to intervene in some situations.

Policymakers, long preoccupied with higher pay's tendency to prompt companies to raise their prices, generating a wage-price spiral, should also be alert to the risks of a so-called profit-price spiral, said Fabio Panetta, an executive board member at the E.C.B. At a conference in Frankfurt last week, he pointed out that in the fourth quarter of last year half of domestic price pressures in the eurozone came from profits, while the other half stemmed from wages.

His concerns have been echoed in recent remarks by the E.C.B.'s president, Christine Lagarde, and the Bank of England governor, Andrew Bailey. Although inflation in Europe has begun to ease from last year's double-digit peaks, the rates remain far above 2 percent, the target of most central banks.

"There's a lot of discussion on wage growth," Mr. Panetta said in an interview this week. "But we are probably paying insufficient attention to the other component of income — that is, profits."

Profit margins at public companies in the eurozone — measured by net income as a percentage of revenue — averaged 8.5 percent in the year through March, according to Refinitiv, a step down from a recent peak of 8.7 percent in mid-February. Before the pandemic, at the end of 2019, the average margin was 7.2 percent.

There has been a similar phenomenon in the United States, where companies reported wide profit margins last year despite the highest inflation in four decades.

Companies could be increasing prices because of higher input costs (the expenses of producing their goods or services), or because they expect future cost increases, or because they have market power that allows them to raise prices without suffering a loss of demand, Mr. Panetta said. Some producers could be exploiting supply bottlenecks or taking advantage of this period of high inflation, which makes it more challenging for customers to be sure of the cause of price increases.

"Given the situation which prevails in the economy, there could be ideal conditions for firms to increase their prices and profits," he added.

"I'm not here to pass a judgment on how fair or unfair" price-setting is, Mr. Panetta insisted, but rather to explore all of the causes of inflation. He is a member of the E.C.B.'s six-person executive board that sets policy alongside the governors of the 20 central banks in the eurozone.

There are sectors where "input costs are falling while retail prices are increasing and profits are also increasing," Mr. Panetta said. "So this is enough to be worried as a central banker that there could be an increase in inflation due to increasing profits."

The average rate of inflation for the 20 countries that use the euro has been falling for five months — to 6.9 percent over the year through March — but core inflation, which excludes volatile energy and food prices, a measure used by policymakers to assess how deeply inflation is embedding in the economy, has continued to rise.

Central bankers tend to focus on the risk that jumps in pay will lead to persistently high inflation, especially in Europe where wages tend to change more slowly than in the United States. The E.C.B. is even developing new tools to measure changes in wages more quickly.

But this intense focus on wages has provoked some criticism. Mr. Bailey of the Bank of England was called out last year for suggesting workers should show restraint in asking for higher wages.

As inflation persists, attention has turned to corporate profits. There is uncertainty about what will happen as prices for energy and other commodities keep falling: Will companies restrain themselves from raising prices further?

Last week, Ms. Lagarde raised the issue of profits, saying there needed to be fair burden sharing between companies and workers to absorb the hit to the economy and income from higher energy prices.

In Britain, Mr. Bailey told companies to bear in mind when setting prices that inflation was expected to fall. Across the Atlantic, last year Lael Brainard, who was then the vice-chair of the U.S. Federal Reserve, suggested that amid high profit margins in some industries, a reduction in markups could bring down inflation.

In Europe, companies were able to protect their profit margins last year from high inflation more than expected, Marcus Morris-Eyton, a European equities analyst at Allianz Global Investor, said.

"Corporates had more pricing power, at an average level, than most investors expected," he said.

This year, he expects there will be more variety in profit margins. "The average European company will face far greater margin pressure this year than they did last year," Mr. Morris-Eyton said. That's because of higher wage costs but "partly because as input costs have fallen, there is greater pressure from your customers to lower prices."

Last year, record-breaking profits by energy producers angered consumers who faced high energy bills, while governments spent billions to protect households from some of those costs. But as energy prices have fallen, consumers are still experiencing rising food prices. In the eurozone, the annual rate of food inflation rose to 15.4 percent in March.

"To a certain extent there's been also an opportunistic move by some big manufacturers to actually increase their prices, sometimes above their own cost increases," said Christel Delberghe, the director general of EuroCommerce, a Brussels-based organization representing wholesale and retail companies. "It's kind of a free-riding on a high price environment."

It's a factor squeezing retail profits, alongside the rising costs of products they buy and resell and higher cost of operations.

There is a notable disparity in profit margins between food producers and retailers, a traditionally low-margin business. Unilever and Nestlé each reported profit margins in the high teens for 2022, while the French supermarket company Carrefour reported a margin of about 3 percent. Unilever raised prices for its products more than 11 percent last year and Nestlé more than 8 percent, but in both cases the companies said they had not passed on all the effects of higher costs to consumers.

Ms. Delberghe said she feared the blame for higher prices was unfairly going to land on retailers. "We're extremely worried because indeed there is this perception that prices are going up and that it's very unfair," she said. Retail businesses are getting a lot of pushback, including from governments trying to take action to stop price increases in stores.

Mr. Panetta said governments should step in where necessary, in part because their fiscal support programs have helped keep profits high. "If there is a sector in particular where market power is abused or there is insufficient competition, then there should be competition policies that should intervene," he said.

But it was also a message to companies.

"It should be clear to producers that strategies based on high prices that increase profits and inflation may turn out to be costly for them," he said.

The cost? Higher interest rates.

As I say I don't think it's necessarily across companies. But I think there is evidence of this in key sectors as in that chart - particularly ones that have an impact on the rest of the economy. From what I've seen there's similar data in the UK and US (less sure) with retailers not increasing their profit margins because they're wanting to keep market share, but other sectors that look very different (my assumption is because of concentrated power, or as the article says supply chain shocks giving them incredible market power).

[Oexmelin]

Isabella Weber: Sellers' Inflation, Profits and Conflict: Why can Large Firms Hike Prices in an Emergency?

https://scholarworks.umass.edu/econ_workingpaper/343/

[Jacob]

Profits don't create inflation.  There are other sources of profits other than raising prices.

Broadly speaking: Price = Cost of Inputs + Profit margin

Sure, if the cost of inputs (from labour or materials or other sources) increase that can drive inflation, but surely so can increases in profit margin? I mean, if the price of a good is doubled and 10% of the increase goes to cover increased labour cost, and 90% of the increase goes to the corporate bottom line surely it's the profit margin that's the main driver of any inflationary pressure?

... and (locally at least) we have clear reports of grocery stores increasing prices by amounts greater than the rise in the cost of inputs.

[Jacob]

It's not a short hand, I'm not trying to be pedantic.  I just have no idea what even the logic is, with or without terms. 

In a free market, companies do not truly have the power to dictate how much profit they're going to make.  Yes, they make a lot of decisions, but competitive pressures pretty much guide them to what those decisions are.  When you're driving to work, technically every turn you make is your decision, but in reality your decisions are railroaded by the necessity to get to work in a reasonable amount of time.  You may feel like you're in control, but in reality it's the geography of the roads and the traffic conditions that dictate what turns you take.

In an idealized free market that is true, but some fields are dominated by a price setter, other fields are dominated by a few large corporations who may collude (or merely coincidentally make similar strategic decisions). In those situations, (some) corporations do have the ability to dictate the profit they make (within some limits).

And if those corporations (in say groceries) decide that a period of inflation is a good time to increase prices significantly above the rise in the cost of their inputs then they are deciding to increase their profit and thus accelerating inflation. That is not illogical at all. It is perhaps an indication that the market is less free than thought - or alternately, that the speed of any market correction is too slow to avoid the inflation pressure that results.

I mean sure, if the grocery stores where 90% of people shop decide to increase the prices of their products significantly to pad their bottom line then they do open themselves up to competition on price. But that competition isn't going to appear overnight - and to really cut into the market share you'll need significant capital investments.... and at that point, the established stores have the option to lower their prices again.

All it really requires is a little informal collusion (or market capture).

[Sheilbh]

Isabella Weber: Sellers' Inflation, Profits and Conflict: Why can Large Firms Hike Prices in an Emergency?

https://scholarworks.umass.edu/econ_workingpaper/343/

Yeah - exactly her. I really need to read her book on China, because it sounds fascinating.

And if those corporations (in say groceries) decide that a period of inflation is a good time to increase prices significantly above to rise in the cost of their inputs then they are deciding to increase their profit and thus accelerating inflation. That is not illogical at all. It is perhaps an indication that the market is less free than thought - or alternately, that the speed of any market correction is too slow to avoid the inflation pressure that results.

I also think it is an expression of inflation expectations/economic shock. My suspicion is that corporates wouldnt be able to do this in a perfectly functioning market, as you say, but also I'm not sure it could happen in "normal" inflation. A key side of price-setting is what your customers will accept and I think if there are shocks with obvious real world causes (pandemics, wars etc) then I think there may be a bit more give from customers, whether consumers or other companies.

I know I always bang on about it but I think it's really important to understand how inflation's been working for the last 3 years because I think the big causes have been shocks to supply and demand from things like disease and war. My view is that we're going into a period when I think there will be more of those types of shocks, particularly from climate events, that will impact prices and markets and I'm not sure the analysis of inflation that is framed around wage-price spiral and the 1970s (oil shock excepted) is the right framework to understand or respond to inflation driven by disease, war, natural disaster - or inflation driven when labour power is still at a historic low.

[Oexmelin]

Yes, that's more or less Weber's suspicions, hence her decision to revisit how prices are set, and the  earlier thinkers of inflation - those who lived through the world wars.

[Sheilbh]

Yes, that's more or less Weber's suspicions, hence her decision to revisit how prices are set, and the  earlier thinkers of inflation - those who lived through the world wars.

Which is interesting because there's also the (unfortunately named) book on neo-liberalism by Quinn Slobodian. In that he looks at the many key thinkers who shape our world right now were from the Austro-Hungarian empire and inter-war Europe. They experienced dangers of politics, including democratic politics, and national sovereignty so wanted to look for ways to protect capitalism and economic life from that through regulatory frameworks but also international institutions and frameworks.

It's interesting to see someone else looking at, I believe, particularly the German post-war experience and more of a general interest in that post-war moment when arguably, in Europe and the US, policymakers were trying to protect democracy and our societies from capitalism and economics (Edit: And, they would argue, against the neo-liberal side that in doing so making them safe for capitalism).

[Grey Fox]

DG & YI seem to live in a totally different world. Share holder value rules everything and increasing profits is a must. Profits have risen(in both relative and total) and somehow that doesn't contribute to the raising of prices?

That's great! Cut your profit in half. Let's see what happens to prices.

[The Minsky Moment]

There isn't any correlation between periods of high profits and high inflation (and vis-a-versa). Profits/GDP in the US are high now, but they were also high in 2005-07 when inflation was low and 2012-20 when inflation was very low.

To the extent there is any connection at all, the causal arrow almost certainly goes the other way.  That is, in an inflationary environment, especially a new one where expectations have not yet fully reset, companies may be able profit, cutting labor costs in real terms by agreeing to wage hikes lower than the inflation rate. The profit margin is widening not because companies are driving artificially high prices increases but because they are suppressing labor costs measured in real terms.

Inflation is a general rise in the price level of an economy and viewing the issue from the micro level of firm pricing can be misleading way to think about it.  Individual firms or industries have pricing power only if they have monopoly or oligopoly power. However, it does not necessarily follow that periods where monopoly power is dominant - like the late 19th century in the US - are inflationary periods.  Quite the contrary- where monopoly power is highly prevalent, demand can be impacted, and historically depressionary conditions were common. 

[Oexmelin]

I would recommend reading the paper, if you haven't.

[The Minsky Moment]

I would recommend reading the paper, if you haven't.

Well now you are putting me in a tough spot.  The paper cites Piero Sraffa, Joan Robinson AND Abba Lerner so I would feel very bad criticizing it.   That sort of thing needs more encouragement.

The analysis of the dynamics of imperfect competition in the front half of the paper is solid; no issues there.

The paper outlines a narrative framework about how monopolistic price increases in individual industries could propagate into a general inflation. But there is no historical argument to show that past inflations have been caused by such a dynamic and the argument to tie it to the current inflation is not overwhelming.  The problem is that there have been many points in history in many countries where monopolistic industry structures have pushed prices up without any impact on general inflation.  As a concrete example, Figure 2 shows profits driving price increases in 2010-11 but without any general resulting inflation and without unleashing the propagation effects.

I didn't find the industry analysis that convincing. Taking the first one - oil is often linked to inflation because the experience in the 70s but there have been other, recent periods of oil and commodity price increases in low inflation environments.  The paper correctly points to the fact that oil companies have been milking price rises for cash and cutting investment.  However, there are reasons for this not mentioned - the majors may be wary about sinking billions into long-term exploration projects given global efforts to transition away from fossil fuels.  Shale players are wary because they overinvested the last boom and got burned.  And it is not clear to me why underinvesting would drive inflation.  The  opposite argument could be made the big scale capital investments in rigs and refinery capacity might drive inflationary pressures given skilled labor shortages and tightness in commodity markets.

[The Minsky Moment]

To be clear, I think that income and wealth inequalities in the OECD and the US in particular are serious problems.  I think increasing shares of income going to capital from already historical high shares is very concerning.  These are concerns that exist in themselves and regardless of any linkage they have to inflation.  It's tempting to give extra credence to an account that names a culprit someone we already think is guilty of another crime.  But that temptation should be resisted; the argument must be evaluated strictly on the merits.