Profit-led inflation

Most textbooks cover cost-push and demand-pull inflation but I have yet to come across profit-led inflation. Paul Donovan, Chief Economist at UBS in London, wrote about the inflation in the last couple of years of which profit-led inflation has been prevalent.

There have been 3 upsurges in inflation of since the COVID-19 outbreak.

1. There was transitory inflation as the fiscal stimulus led to people wanting to spend more as supply chains were struggled to keep a pace with this demand for durable goods.

2. The war in Ukraine saw a spike in energy prices as economic growth recovered from the pandemic. This was independent of transitory inflation.

3. Profit-led inflation – this is when companies tell consumers a convincing story that allows them to increase their price with out reducing demand for the product and therefore making it more inelastic. Consumers believe the price increase is ‘fair’ or ‘justified’.

Two types of companies.

• Those that raise and lower profit margins and prices as demand fluctuates which means that inflation is demand driven.These are companies that have weaker pricing power but strong brand values and need repeat customers.

• They convince customers that something has happened outside their control or the customer doesn’t hinder stand the companies’ true costs. Stories about agricultural prices increasing, climate change etc makes it seem fair but the majority of the cost is in labour and they haven’t been rising as much

To control profit-led inflation raising interest rates is one option in that it should reduce demand and squeeze prices. Convincing customers that they are being taken advantage of, is a faster and less damaging way of reducing inflation. Also social media has a role to play here by facilitating customer thoughts on the product.

Source: What profit-driven inflation might mean

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