Soaring Profits, Inflation and Businesses Raising Costs on Goods

Instead of management collecting on higher profit margins, certain businesses could raise wages and attract workers during this “Great Resignation” (where many workers are quitting) that American society is having.

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If This is a Wage-Price Spiral, Why Are Profits Soaring?

That’s the question millions are asking, even if economic reporters are not. The classic story of a wage-price spiral is that workers demand higher pay, employers are then forced to pass on higher wages in higher prices, which then leads workers to demand higher pay, repeat.

We are seeing many stories telling us that this is the world we now face. A big problem with that story is the profit share of GDP has actually risen sharply in the last two quarters from already high levels.

The 12.4 percent profit share we saw in the second quarter is above the 12.2 percent peak share we saw in the 00s, and far above the 10.4 percent peak share in the 1990s. In other words, it hardly seems as though businesses are being forced by costs to push up prices. It instead looks like they are taking advantage of presumably temporary shortages to increase their profit margins.

This doesn’t mean that some businesses are not in fact being squeezed. We are seeing rapidly rising wages for low-paid workers. That is putting a strain on many restaurants and other businesses that pay low wages.

That is unfortunate for them, but this is the way capitalism works. The reason we don’t still have half our population working on farms is that workers had the opportunity to work at higher-paying jobs in manufacturing. If workers now have the option to work at better-paying jobs, the restaurants that can adapt to higher pay will stay in business, but some obviously will not.

A Lower Unemployment Rate, Inflationary Pressures, and Central Banks in Policy

How low can the unemployment rate go without causing excessive inflation? It’d be a nice experiment to find out. Usually not mentioned is that big banks – which of course wield pretty significant power – dislike inflation because they’ll typically have a supply of long-term loans on their books. Those loans stand to depreciate in value with higher inflation, and that’s largely the reason why there’s such pressure to keep inflation lower than necessary through central bank interest rate increases.

The loans of banks and other financial corporations typically are set at a fixed rate, so again, the repayments of those loans will be worth less to them if inflation rises. For one example, if a bank offered a 5 percent home loan while expecting that inflation would be 1 percent, the bank would assume that it would receive a real interest rate of 4 percent. If the inflation rate actually becomes 2 percent, the bank will take a considerable profit loss (receiving a 3 percent real interest rate) compared to what it expected, as there’s less loan money for it in real terms because of the higher inflation.

The interest rate increases do of course have the side effect of slowing the economy, and that contributes to a higher unemployment rate that leaves lower-income employees less bargaining power for wage increases. Along with how interest rate raises (beyond a certain point, of course) lead to less job opportunities, the point about worker bargaining potential is important, as a central bank wields a lot of power in society. It’s preferable to see that power used for the common good instead of for the financial conglomerates that have caused too many problems already.

Just four years ago the Congressional Budget Office put the floor of the unemployment rate at 5.5 percent. This estimate implied that if the unemployment rate fell below this level that the inflation rate would begin to spiral upwards.

The unemployment rate has now been well below this level for more than two-and-a-half years, and there is still no evidence of an inflationary spiral. In fact, the inflation rate remains well below the Federal Reserve’s 2 percent target.

If the Fed and Congress had tried to craft monetary and fiscal policy around this 5.5 percent figure, as many economists advocated, millions of workers would have been needlessly denied the opportunity to get jobs. Tens of millions would be looking at lower wages, as the tighter labor market has finally allowing workers at the middle- and bottom-end of the labor market to finally share in the gains of economic growth.