'Greedflation' myth hides real causes of inflation

Claiming "corporate profits have been a major driver of inflation", it "aims to recommend practical and effective measures to curb price-gouging and protect the financial interests of all Australians".

The ACTU is not the first to try to sheet home blame for inflation to the corporate sector. However this view, dubbed 'greedflation', fundamentally mistakes cause for effect, leading to a distorted understanding of inflation and ineffective or retributive policy solutions aimed at policing corporate behaviour.

There are big holes in the greedflation hypothesis. The biggest is that greedflation has no causal mechanism.

As a general rule, companies always act to maximise their profits. Their prices are set in accordance with that goal. Therefore profit margins don't just suddenly rise across whole industries and countries at the same time for no reason.

If corporate greed is the cause of inflation, something must have fundamentally shifted the bargaining power of companies vis-a-vis consumers.

Some have pointed to corporate opportunism from supply-side blockages as a result of the pandemic and energy price increases from the Ukraine war (what you might think of as supply side inflation).

But these factors would increase production costs and therefore decrease profit margins in the short term, not increase them. Many businesses are not able to pass on all the increased costs to consumers, much less larger increases in prices.

So, did companies just suddenly all agree to become greedier in late 2021? Have they become slowly less greedy across 2023 as inflation has come down?

On the contrary, there is a good explanation for why corporate profits have risen, that also explains why inflation is high and unemployment is at historic lows. Excessive fiscal and monetary stimulus across the world in 2021 (especially the second half of 2021) caused an excess of demand in the economy.

That shift in demand resulted in some extra production (more jobs). However, as the rise in demand exceeded the productive capacity of the economy, companies could charge more for their goods. The profit maximising behaviour of companies meant higher prices (inflation) and higher profits.

'Greedflation' is not the cause of the current mess, it is evidence of poor monetary and fiscal policy. An Economist headline put it more simply: "Greedflation is a nonsense idea."

This lack of foundation is not the only problem with the ACTU's proposed inquiry into unfair pricing.

In an opinion piece this week, Prof Fels justified his participation on the basis that companies might have "unfairly and unjustifiably increase[d] prices" and therefore a responsible government should take steps to ensure this price gouging wasn't happening.

It is hardly surprising Prof Fels would express such a view, he was the head of an institution (the ACCC) whose fundamental premise is that government is the protector and guarantor of competition in the market.

This premise, too, is incorrect. Competition policy is mostly about protecting smaller companies from bigger ones, often at the expense of consumers. As markets have become more globalised, and barriers to entry (both natural and government-created) have fallen, competition has increased. Governments should not stand in the way.

In fact the whole idea the government has any business stating what a 'fair' price is for goods and services is patently absurd. The fair price for a good is the price agreed between willing buyers and sellers in an informed market. Government's role is to police fraud and misrepresentation, not competition.

Not that government hasn't tried - grocery watch, fuel watch, energy watch, YourSuper, anti-dumping laws - the policy graveyard is littered with failed or mostly ineffective government policies aimed at rooting out so-called price gouging.

However, it is important to understand the bigger picture context of these claims and initiatives.

The greedflation claim, together with furious refutations of the role of wages in the current bout of inflation (something no one has credibly argued), seem to be about buttressing the case for wage rises linked to the level of inflation.

A case which is, at least in part, government policy.

This amounts to the government seeking to apportion the pain of the necessary correction to living standards in accordance with its political priorities.

But in doing so it runs a big risk: if high inflation becomes embedded in wage expectations, we could be creating a disastrous, self-perpetuating inflationary cycle.

Arguably, government policy that flirts with this outcome is deeply irresponsible, hence the need to shift the debate on inflation away from wages and towards profits.

But there is an even broader issue here. Underlying much of the debate around the economy, not just wages and inflation, but even the role of the Reserve Bank seems to be an attempt to effectively undo the post-1970s economic settlement that assigned macroeconomic stabilisation to monetary policy and microeconomic efficiency issues to fiscal policy.

The dissidents seek to de-emphasise monetary policy, especially the role of managing inflation in monetary policy, in favour of an approach with a greater role for fiscal policy and an equal focus on maintaining full employment (or even unsustainable levels of employment).

At the core, as Treasurer Jim Chalmers argued in his essay in The Monthly earlier this year, is the return of government to a more central role in the economy, along with bodies like the ACTU.

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The ACTU inquiry will likely generate a lot of hard luck stories, and probably a fair bit of attention in support of this agenda, distracting the public from the failures of government that caused this inflation.

While we should not overlook the genuine hardship the current inflationary episode has caused, too many policy initiatives are based on mistaken or misleading interpretations of economic conditions and effects.

Regardless of your ideological positioning, the policy response should be based on evidence, not superstition.