Title page image-- Inflation Is Surging: Round Up the Usual Scapegoats

By John Miller | July/August 2022

This article is from Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org

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Inflation in the U.S. economy has reached levels not seen for four decades. The June 2022 inflation rate was 9.1%. That’s the increase over the last 12 months in the Consumer Price Index—a measure of the average price of 500 goods and services purchased by a typical urban consumer. Inflation rates haven’t been that high since 1981. Making ends meet has become more difficult for many. In May, energy prices were more than a third higher (34.6%) than they had been a year earlier. Food prices were 10.1% higher than a year earlier. In mid-June the average price of a gallon of gas hit $5.02. And a June survey conducted by The Economist and YouGov found that more than half (56%) of respondents thought the U.S. economy was in a recession.

In retrospect, today’s elevated inflation rates are hardly surprising, though few economists or policymakers anticipated them ahead of time. The Covid-19-induced economic shutdown created shortages and disrupted global supply chains. Along with these supply disruptions, both monetary and fiscal policy bolstered demand. Russia’s invasion of Ukraine made energy and food shortages yet worse. In reaction to the pandemic shutdown, the Federal Reserve slashed interest rates on short-term borrowing and flooded the banking system with oceans of cash. The federal government spent heavily to provide for people’s needs as Covid-19 put people out of work. Those policies maintained demand and provided the spending necessary for a rapid recovery.

The limits to supply, combined with the maintenance of demand, would have been enough to generate some inflation. At the same time, large corporations use their market power to push up prices well beyond simply passing their higher costs onto consumers, especially in response to shortages.

Instead of trying to make sense of the multitude of factors that pushed up prices, the conservative economists, both Republicans and Democrats, have fixated on the usual scapegoats: government spending programs that were more generous than they would have liked and tighter labor markets that have required employers to pay higher wages. And for good measure, they have berated the Fed for failing to step in more quickly to relieve the labor market pressure by jacking up interest rates to tamp down spending and slow economic growth and job creation. So what’s the real story on inflation? Let’s begin by debunking the ideological coverup of the multiple causes of inflation that together have worsened inequality.

Too Much Spending: Did the Government Do it?

It’s easy enough—in the sense that it’s simplistic—to explain today’s inflation by chalking it all up to too much government spending and borrowing. John Cochrane, a conservative economist, did just that in the Wall Street Journal this June, proclaiming that, “The current inflation was sparked by fiscal policy—the government printed or borrowed about $5 trillion.” Cochrane was not alone. Last year, Lawrence Summers, the influential former Clinton administration Treasury Secretary, warned that the American Rescue Plan Act stimulus package enacted in March 2021 would push spending beyond the capacity of the economy to meet the additional demand, given Covid-19 and its impact on employment and demand, thus pushing up inflation rates.

It is true that without the government spending needed to restore demand in a collapsing economy there might have been little inflation. Still, no matter how ideologically effective it might be to single out government spending as the chief cause of today’s rapid inflation, it is hardly a convincing explanation in an economy beset with shortages and supply-chain disruptions, and war in Ukraine—plus monopolistic pricing by large corporations (more on that below).

Dutch economist Servaas Storm calls Cochrane’s dismissal of any role of shortages and supply-chain snarls in causing inflation “a stunning disregard for the empirical evidence.” Cochrane’s failure to mention either the ongoing pandemic or the war in Ukraine makes that disregard even more stunning.

A far better way to assess the effect of the U.S. stimulus spending on inflation is to compare the inflation rates in the United States with those in other advanced countries that enacted considerably less generous stimulus packages. Altogether, U.S. government stimulus spending during 2020 and 2021 added up to 26.5% of (2020) GDP, more than double the 11.3% average of the 28 E.U. countries. In 2021 the U.S. inflation rate was 7.0%, 1.7 percentage points greater than the 5.3% average for the E.U. economies. And with war in Ukraine and a worsening energy shortage, the E.U. inflation rate of 8.85% in May 2022 was higher than the U.S. inflation rate of 8.6% in May.

So, it seems that cutting the U.S. stimulus packages down to half their size (or to even less) would have reduced the U.S. inflation rate in 2021 by less than two percentage points. Those cuts would have come at a tremendous cost. Stimulus spending lifted 3.2 million children out of poverty and provided income support for families, especially low-income families, to help them weather the economic shutdown. That stimulus spending, moreover, helped the U.S. economy replace the output lost in the economic downturn more quickly than the E.U. economies, and helped add back the jobs lost during the pandemic downturn in half the time it took the long, sluggish recovery of the U.S. economy from the Great Recession.

The remaining 2021 5.3% inflation rate in the United States and the corresponding rate in E.U. economies could hardly be attributed to “excessive” stimulus spending. The stimulus spending is part of the story. So, too, is the Fed’s action to support that spending. The Fed pushed short-term interest rates down to near zero and each month purchased $80 billion of Treasury bonds to finance the federal deficit, and to shore up corporations the Fed bought $40 billion of their bonds each month. Much of the economic establishment has chastised the Fed for not cutting back that support and slowing the economy at the first sign of inflation. As economist Gerald Epstein, a co-director of the Political Economy Research Institute, points out, their position is rooted in the notion that the source of inflation is “too much money chasing not enough goods,” the phrase made famous by Milton Friedman, the famous conservative economist. But like Friedman, their focus is on “too much money,” the demand side of the phrase. Any meaningful explanation for inflation must focus not just on “too much money” but on “not enough goods,” as well—the bevy of supply-side issues that beset the United States and other advanced economies. Let’s now turn to those supply-side pressures on inflation and show how profits did considerably more to push up prices than wages did.

Supply-Side Price Pressures: Wages Take the Blame, Profits Get the Gains

Wages Take the Blame

Rather than sorting through those supply-side price pressures, some of the most influential economic voices have singled out “wage inflation” —nominal wage increases not corrected for inflation—and the possible return of a wage-price spiral like that of five decades ago as public enemy number one. Central banks “have to prevent a wage-price spiral,” Martin Wolf, the chief economic commentator for the Financial Times warned in February. “Monetary policy must be tight enough to create/preserve some slack in the labour market.” As for Summers, today’s “super tight labor markets, say wage/price spiral,” according to a Tweet he posted earlier this year.

Their argument goes something like this. First, in a recent paper, Summers and fellow economist Alex Domash emphasize that labor costs typically represent more than two-thirds of all business costs. Also, today’s labor markets are unusually tight, even tighter than the current 3.6% unemployment rate suggests. And not surprisingly, nominal wages (with no correction for inflation) are increasing at their fastest rate in two decades. From May 2021 to May 2022 the median (or middle) wage of all workers increased 5.0%, the median wage of leisure and hospitality workers increased 5.8%, and the median wage for the lowest paid quarter of the workforce increased 6.1%, according to the Federal Reserve Bank of Atlanta Wage Growth Tracker.

There is a genuine labor shortage. Today the number of job openings is far greater than the number of unemployed people looking for work. In March 2022, the ratio of job openings to unemployed workers reached 1.94, the highest level on record. And labor costs are typically the largest cost for businesses.

But none of that makes blaming workers’ wages for the outbreak of inflation a plausible claim. Nominal wage increases have not kept up with current inflation rates in the current upsurge, reducing workers’ real wages (wages corrected for inflation or purchasing power), which have barely budged for decades. The Congressional Research Service reports that from 1979 to 2019, median real wages, those of the 50th percentile of wage workers ranked by income, increased just 8.8%, and the wages of workers at the 10th percentile—the lowest-waged workers—increased even less, just 6.5%. In addition, workers’ bargaining power has been under attack. More and more, especially during Republican administrations, labor laws have gone unenforced, the National Labor Relations Board has done less and less to protect workers who attempt to organize unions from being illegally fired, more states have enacted right-to-work laws, and states have regularly overridden (or pre-empted) local pro-labor regulations. Finally, in 2021, just 10.3% of wage and salary workers were union members, a little over half of the 20.1% rate in 1983 (the first year that the Bureau of Labor Statistics collected comparable data).

To suggest that, in the wake of diminished union membership and the proliferation of anti-worker-public policies, workers’ wages are the chief cause of today’s high inflation rates just doesn’t add up. For starters, while workers’ wages, even those of low-income workers, have gone up over the last year, nevertheless, as pointed out above, the increase is considerably slower than the 9.1% inflation rate. So, workers’ declining real wages have dampened inflation, not accelerated it. And even with a labor shortage and the much-reported Great Resignation, workers are getting no more of the economic pie than they were before the pandemic. In the first quarter of 2022, labor’s share of national output (the ratio of workers’ compensation—wages and benefits—to national income) was 62.9%, the near equivalent of their 62.7% share in the fourth quarter of 2019, on the eve of the pandemic crisis. That was enough for Julia Coronado, president of MacroPolicy Perspectives, an independent research firm, to conclude that this is not “an overheating labor market, but rather one where labor is holding its own.” And clearly that’s not to the liking of many establishment economists.

Profits Get the Gains

A study by Josh Bivens, director of research at the Economic Policy Institute, isolates the three main components of costs: labor costs, non-labor inputs, and the “mark-up” of profits. Using data for nonfinancial corporations—companies that produce goods and service and make up about three-quarters of the private sector—he found that “corporate profits have contributed disproportionately to inflation.” From the second quarter of 2020 (when the economy began to recover) to the fourth quarter of 2021 labor costs per unit of output increased 7.9% and non-labor input costs increased 38.3%, while corporate profits increased 53.9%.

That rising profit margins would be a major driver of higher prices is not unexpected, but just how much they have contributed to inflation was surprising. A few giant companies have long dominated much of the U.S. economy and dulled competitive pressures, allowing them to pass along their high costs by increasing the prices they charge consumers. A 2022 study by the Federal Reserve Bank of Boston found that the average share of sales of the largest five companies in an industry increased from 53% in 2005 to 57% in 2018. Other research has shown that these giant corporations have also used their market power to keep a lid on wage increases. A 2022 study by the Biden administration’s Department of the Treasury reports that the effect of high levels of employer power have reduced employees’ wages by roughly 20% below what they would have been in a fully competitive labor market. (See Arthur MacEwan “Power, Wages, and Inequality,” Dollars & Sense, May/June 2022.)

While there is little reason to think that corporate greed is any greater today than it was in earlier periods, large corporations have been able to widen their profit margins by taking advantage of shortages, which then allows them to get away with pushing up their prices. In a January 2022 Senate hearing, even Federal Reserve Chair Jerome Powell conceded that corporations with monopoly-like powers “are raising prices because they can.” And Wall Street Journal reporter Dion Rabouin reports that nearly 100 of the biggest U.S. publicly traded companies booked 2021 profit margins that were at least 50% higher than their 2019 levels. Also, as Bivens has emphasized, unlike in previous economic recoveries, the exercise of corporate power has gone more exclusively toward pushing up prices rather than clamping down on wage growth, which is why swollen profit margins account for such a large share of price increases.

Storm, the Dutch economist, sums up the evidence from his study of the cost pressures on prices this way: “A fair assessment of what has happened during 2020–2022 is that U.S. inflation has been driven less by (lagging nominal) wage increases and more strongly by increases in profit mark-ups. Fears of a building wage-price inflationary spiral appear to be misplaced.”

How Best to Fight Inflation

You would think the sort of fair assessment provided by Storm and others would influence the policies being pushed by many economists. But the calls for the Fed to raise interest rates enough to prevent a wage-price spiral even at the cost of a recession have only multiplied. Former Treasury Secretary Summers now argues that the Fed will need to increase interest rates enough to push unemployment rates above 5% for five years, or to far higher unemployment rates for a shorter period, to contain inflation. Implementing draconian interest rate hikes to combat a wage-price spiral that isn’t visible in the data would cause much greater suffering than the economic hardships created by the current inflation rates. As the economy is driven into a recession, tens of millions of workers would lose their jobs and wages would stagnate, even though profits have done far more than wage increases to fuel inflation. On top of all that, this class-war macroeconomic policy strategy, which is intended to repress wages to assure robust profits, would fail to address the multiple causes of inflation.

What is needed instead is a strategy that addresses the different pressures that have pushed up prices—a strategy that would contain profits and push up real wages, both constraining inflation and reducing economic inequality. It is also important to recognize that there are no quick fixes to many of the causes of inflation—including pandemic-induced shortages exacerbated by the war in Ukraine. The Fed should do less to raise interest rates and more to reel in the speculative fever it unleashed through its rock-bottom interest rates and its outsized purchases of corporate bonds. For starters, it should increase margin requirements, the percentage a purchaser of a financial asset must pay from their own cash instead of by borrowing.

Concerns about the inflationary effect of government stimulus spending and borrowing should be addressed by raising taxes on the rich, who have prospered while others have suffered. There is no shortage of progressive proposals to do that. Increasing taxes on corporations’ swollen profits by reversing President Donald Trump’s corporate tax cuts is a good place to start. But making the rich pay taxes on their wealth as they accumulate it (by taxing unrealized capital gains) is also crucial. Those taxes would reduce government deficit and borrowing, would help to correct today’s gaping inequalities, and could even finance much-needed relief for those hit hardest by inflation.

Strategic price controls are also needed. Caps on the prices of energy, fuel, and basic food items would be especially beneficial to low-income households who spend more of their income on those necessities. Several European governments, as Storm points out, are already regulating energy prices to protect consumers. Serious attention needs to be devoted to untangling the supply-side pressures on prices from the ongoing pandemic and now the war in Ukraine. But that will take time. Beyond better public health policies and providing health care universally, government infrastructure expenditures are needed to relieve bottlenecks in the supply chain to ease transportation problems and shortages of computer chips and other key inputs. Also, the shortage of workers, such as long-distance truckers, health care workers, public school teachers, and other public-facing service jobs, needs to be solved by making their working conditions less dangerous and debilitating and by boosting their compensation.

Two anti-inflation measures are especially important over the long term: It’s critical that the government undertake measures to reduce the price-setting powers of corporations through aggressive anti-trust action. That should empower workers and consumers. Even more critical is for public policy to accelerate our transition away from our dependence on fossil fuels and transition to a net-zero carbon economy. Economist Robert Pollin, a co-director of the Political Economy Research Institute, has argued that those energy- transforming policies could keep the inflation rate within a reasonable range while supporting fulsome wage gains for workers.

These are all important steps toward initiating positive economic policy. With these measures in place, we could celebrate much-need wage gains and government spending that provides relief to the vulnerable, instead of making them the scapegoats blamed for an inflation they didn’t cause.

is a professor of economics at Wheaton College and a member of the Dollars & Sense collective.

Sources: John H. Cochrane,“The Federal Reserve Can’t Cure Inflation by Itself,” Wall Street Journal, June 27, 2022 (wsj.com); Robert Armstrong and Ethan Wu, “A third option in the inflation debate,” Financial Times, Feb. 22, 2022 (ft.com); Alex Domash and Lawrence H. Summers, “A labor market view on the risks of a U.S. hard landing,” NBER Working Paper No. 29910, April 2022 (nber.org); Dean Baker, “More Thoughts on the great Inflation Debate,” Center for Economic Policy Research, Jan. 29, 2022 (cepr.org); Josh Bivens, “Wage growth has been dampening inflation all along—and has slowed even more recently,” Economic Policy Institute, posted May 12, 2022 (epi.org); “Corporate profits have contributed disproportionately to inflation. How should policymakers respond?’ Economic Policy Institute, Working Economics Blog, April 21, 2022; Servaas Storm, “Inflation in the Time of Corona and War,” Center for New Economic Thinking, Working Paper No. 185, May 30, 2022 (ineteconomics.org); John Schmitt and Ben Zipperer, “Dropping the Ax,” Center of Economic and Policy Research, March 2009; “Worker Rights Preemption in the US,” Economic Policy Institute, November 2017; Falk Brauning, Jose Fillat, and Gustavo Joaquim, “Cost-Price Relationships in a Concentrated Economy,” Federal Reserve Bank of Boston, Current Policy Perspectives, May 23, 2022 bostonfed.org; C.J. Polychroniou interview of Robert Pollin, “Nationalizing Fossil Fuel Industry Is a Practical Solution to Rising Inflation,” Truthout, Feb. 24, 2022 (truthout.org); Real Wage Trends, 1979 to 2019,” Congressional Research Service, December 29, 2020 (crsreports.congress.gov); David Harrison, “Workers’ Share of Pie Barely Budges,” Wall Street Journal, May 31, 2022; “The State of Labor market Competition,” U.S. Department of the Treasury, March 7, 2022 (home.treasury.gov); “Why corporations are reaping record profits with inflation on the rise,” PBS News Hour, Apr 12, 2022 (pbs.org); Phillip Aldrick, “Larry Summers Says US Needs 5% Jobless Rate for Five Years to Ease Inflation,” Bloomberg, June 20, 2022 (Bloomberg.com); Larry Summers Tweet (twitter.com/LHSummers, February 5, 2022, 6:32pm); Olafimihan Oshin, “56 percent in new poll believe US is in recession,” The Hill, June 16, 2022 (thehill.com); C.J. Polychroniou interview of Gerald Epstein, “Hiking Interest Rates Protects Financial Assets of the 1% at Workers’ Expense,” Truthout, July 7, 2022.

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