August 05, 2024
By Mike Walden
Raliegh, NC − Although the pace at which prices are rising has moderated, prices are still going up. In 2021, average consumer prices surged 7%, in 2022 they jumped 6.5%, in 2023 prices went up a more tolerable 3.4%, and the latest reading for 2024 shows consumer prices are up 3.5% from the same period in 2023. Cumulatively this puts prices up over 20% since 2021.
As long as consumers’ financial resources increase at the same or a higher rate than price inflation, then there’s no loss of purchasing power. But most people know this hasn’t happened. Indeed, from 2021 to now, the average consumer’s purchasing power is off by 5%.
I mention these statistics to show that inflation is still a problem, which is something most people know. The next question is, why is inflation still a continuing issue?
When inflation began its spurt in 2021 there was an easy reason — consumers were trying to buy more than sellers had to offer. Consumers were flush with cash as a result of the COVID relief programs enacted in both 2020 and 2021. These programs culminated in $6.5 trillion being rapidly pushed into the economy. Initially there were few buying opportunities as large parts of the economy had not yet reopened.
When consumers were able to buy, they had what economists call ‘pent-up demand’ — meaning they wanted to buy a lot! Typically this wouldn’t have been a problem, but there was another issue that had emerged, supply-chain problems. So, in short, consumers wanted to really buy, but many of the shelves were bare. In this situation, it was inevitable prices would rise substantially, which they did.
But today, consumers have spent most of the COVID money, and the supply-chain has mostly been fixed. Yet inflation is running hotter than the 1.8% in 2019, before the pandemic. With inflation now at a rate of 3.5%, the question is why isn’t it closer to its pre-COVID level?
There are a couple of potential reasons. One is strong economic growth. The economy in 2023 was as strong as it was in 2019, before the pandemic. Economic growth rates in the periods were virtually the same. Job growth has also been solid, with salaries from new jobs giving consumers more spending power. Even some sectors that were slowing have come back. Manufacturing is a good example. For almost a year manufacturing activity was declining. But in the last two months, the manufacturing sector has revived.
The point is that, even with the supply chain fixed, more consumer spending can put a limit on how much inflation can be curtained. And we continue to see solid gains in consumer spending.
There are some economists who argue the Federal Reserve didn’t raise interest rates enough to provide the necessary cooling in consumer spending that would have moderated inflation faster. Of course, the Fed has to balance aggressive interest rate hikes to combat inflation against the possibility such actions may result in a recession.
The last reason I will discuss is taken from the title of today’s column. This is whether businesses are purposely keeping prices high to boost profits. This kind of action is called “greedflation.”
Before addressing the question, let me step back and talk about a business’s ability to set prices. I learned about prices in academia, but I also had hands-on training at a retail furniture store where I worked for seven years. Any business wants to maximize its profits, which is the difference between revenues and costs. You would think an obvious way to increase profits is to simply increase the price of what the business sells. For a furniture store, this would mean increasing the prices of sofas, chairs, dining room tables, beds, etc. If there was no change in what the furniture retailer paid for the products, then increasing the price of items for sale would boost profits.
But there’s a problem with this logic. If furniture retailer A increases its prices, but furniture retailer B doesn’t, then what’s to prevent people who were ready to buy from A to instead buy from B? Losing customers reduces sales and lowers profits.
Business owners know this. The furniture company I worked at would sell from their inventory, because customers generally wanted their furniture soon. Worse than selling at a low price and making a low profit was to not sell and make no profit. This is why my boss would often send me to rival stores to check their prices — remember, this was 50 years ago before computers and web sites. It’s the realization that customers have options that ultimately keeps prices under control.
Of course, if the furniture retailer finds it has to pay more to the manufacturers of the furniture it sells, then the retailer will likely increase its prices. This happened during the supply-chain problems caused by COVID. But as prices for many inputs have come down — although not all the way to pre-Covid levels — retail prices have followed.
Hence, to claim that uncontrolled greed is causing retailers to continually push up prices goes against the reality of how prices are set in competitive markets, which dominate our economy.
A way to directly investigate if “greed inflation” is at work is to look at profit rates. The profit rate is simply the percentage of a company’s revenues that are profit. Today’s profit rates are in line with their historic average of the last forty years. Profit rates are near 4%. Interestingly, profit rates were higher during the previous forty years, between 1940-1980. The reason is likely the increase in international trade, which has brought more competition.
There are several reasons why prices are still higher than we would like. But is “greedflation” one of them? You decide.
Mike Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.
Source: NC State University
Image Credit: NC State University
