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Profits now key driver of inflation

Taking Aim at Sellers’ Inflation

Isabella M. Weber, Assistant Professor of Economics at the University of Massachusetts Amherst, argues in an article recently published in Project Syndicate that economists and political leaders at various institutions have come to acknowledge that corporate profits are a significant driver of inflation today.

Recent studies by the European Central Bank, OECD, Bank for International Settlements, and the European Commission have all shown that rising corporate profits have contributed significantly to inflation in Europe. This "sellers' inflation" occurs when firms pass on cost shocks to consumers by increasing prices to protect or enhance their profit margins. The historical success of firms in protecting their margins has led to a shift in inflation drivers, with profits now accounting for 40% of inflation, surpassing labor costs.

Despite this new understanding, the standard policy response to inflation remains to hike interest rates, which can have negative consequences such as higher unemployment, recession, and financial instability. Instead, a new strategy is needed to discipline runaway profits, incentivize investment, increase productivity, and encourage fair pricing and selling more products.

Some countries have adopted creative approaches to combat inflation successfully. It is crucial for policymakers to implement policies based on this new understanding to effectively address inflation. Otherwise, it may be better to pause rate hikes rather than risk further tightening that could have detrimental effects on the economy.

Read the full article here