MNI INTERVIEW: Companies' Contribution To US Inflation Falling

Corporations' profit margins contributed little to U.S. inflation in the first quarter and will be an even smaller driver of price pressures going forward as inflation eases, Federal Reserve Bank of Kansas City economists Andrew Glover and Jose Mustre-del-Rio said in an interview.

Firms' mark-ups spiked in early 2021 when costs were actually falling, and profit margins rose at higher rates than inflation. But by the end of 2021, as inflation started picking up, profit growth was already a falling share of price pressures and contributed less than 20% of overall inflation in 2022, according to a recent paper by the economists.

That trend accelerated in the first quarter. According to Commerce Department data released Thursday, corporate profits slipped 5.1% in the first three months of the year and contributed only 0.2 percentage point to the 5.3% GDP deflator inflation rate, Glover told MNI. Due to data limitations, the economists use GDP deflator as their inflation rate; it has been running slightly hotter than the Fed's preferred PCE inflation measure since the pandemic.

"In past recoveries, we see this type of trend happen pretty consistently. Early in the recovery, profits contribute a lot to inflation. That falls as the recovery continues and eventually profits contribute very little," Glover said. As expansions mature, "the contribution of profits turns disinflationary, masked by inflationary pressures of labor and other nonlabor costs," Mustre-del-Rio added.

STICKY PRICES

Macroeconomists at the Fed have been generally dismissive of the argument that increased corporate power has driven pandemic-era inflation. Glover and Mustre-del-Rio's paper notes data going back to the 1940s that shows inflation from corporate profits climbs sharply in the first few quarters after the end of a recession then descends as recoveries continue.

The Kansas City Fed economists found inflation would have averaged 3.4% in 2021 based solely on growth in profit margins, but because costs actually fell over the period, average inflation registered just 2.7%. "In 2021 wages weren’t growing yet, but if you’re a firm you saw the writing on the wall -- it was harder to find workers," Glover said.

Firms anticipating higher replacement costs for inventory and rising labor costs preemptively set higher prices, while their actual costs take time to catch up. Pay freezes for example typically are lifted only gradually as contracts are renegotiated or new workers hired, Mustre-del-Rio noted.

Over the 2021-2022 period, corporate profits contributed 41% to inflation, "more or less the same" as the the historical average of 59%, Glover said.

EXPECTATIONS NORMALIZING

Signs that firms' inflation expectations are moving toward pre-pandemic averages bode well for the prices businesses will charge customers and for inflation overall, Glover and Mustre-del-Rio said.

The Cleveland Fed's national Survey of Firms’ Inflation Expectations show expected CPI inflation over the next 12 months has declined to 5.0% in April from a pandemic high of 7.3% in October. The Atlanta Fed's Business Inflation Expectations survey of firms in its district has also fallen to 2.9% from a high of 3.8% last year.

"Expectations of firms are contributing less to inflation now than last quarter," Glover said. "It’s still higher than what would get us to target, but it’s moving down."

Still, worries remain that the labor and nonlabor costs now driving inflation won't ease so quickly. Former Fed Chair Ben Bernanke and former IMF chief economist Olivier Blanchard said in a paper this week "a very tight labor market has begun to exert increasing pressure on inflation" and can only be reversed by "policy actions that bring labor demand and supply into better balance."