Understanding Greed-flation

Understanding Greed-flation

Subject : Economy

Section: Inflation and unemployment

Mechanics of inflation:

• Inflation is the increase in the overall level of prices. In an ideal situation, for an economy to grow, low inflation is desirable.
• This can be understood through a virtuous cycle of inflation, investment and monetary expansion.
• Inflation is a signal of rising demand, to cater which fresh investments are made to seek profit. At the same time the banking system, driven by the central bank, keeps pumping money to cater to the credit needs of these investments.
• The reason for the increase in price of anything is the interplay of demand and supply. So it is with inflation, where the two forces of demand and supply determine inflation.
• If the price of input rises, there is a cost push inflation. This could be due to, a disruption in supply which could be the result of war or natural disaster, or due to speculative activity in the commodity market resulting from a loose money policy.
• If there is an increase in demand there is demand pull inflation. This could either be due to an easy credit policy that increases the spending power of people, aur due to increase in number of jobs.
• Sudden rise in inflation could sometimes be the result of wage-price spiral, where by seeking higher wages to account for increased prices of goods, inflation is further pushed up, by more money now bidding on the same available output of the economy.

Recession or deflation, and reflation:

• In the event of recession, as seen after Covid-19 pandemic, output, prices and investments all fall as there is a general negative outlook regarding demand. This is a state of deflation.
• To enable recovery, the central banks as seen in the recent past pump money into the economy to re-inflate the economy. This is the cycle of reflation.
• During reflation, as more and more investments are made, more jobs are created, there is a rise in inflation and the economy is said to be ‘heating up’.
• In this situation, as more jobs are created, unemployment rate falls. This should result in a greater share of wage in relation to the profit.
• But what has been noticed in the recovery after Covid is the reverse, profits have been rising as wages have remained stagnant. This has been explained by a profit-inflation spiral, where an increase in profit markup in turn adds to further inflation. The above phenomenon has been described as “Greed-flation“.
• Higher profits can only be the result of (i) higher sales (with the same profits margins); (ii) higher profit margins (with the same level of sales); (iii) a combination of higher sales and higher profit margin.
• As per CMIE analysis, 60% of the growth in net profit can be attributed entirely to the increase in profit margin. The increase in sales contributed an additional 36% and the rest was a bonus from a combination of the two.

Policy implication: A temporary excess profit tax has been suggested as a measure to address profit driven inflation. This should prohibit price gouging. But the problem with this is who should decide which firm is resorting to gouging. And further it would disturb free market dynamics.