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While the central banks and the governments is not acknowledging it, the private bankers and economists are constantly labeling current inflation trend as the profit led inflation. This morning UBS comment https://www.ubs.com/global/en/wealth-management/insights/chief-investment-office/market-insights/paul-donovan/2023/does-growth-spill-over.html?caasID=CAAS-ActivityStream is just one example in this stream:

Euro-area consumers have suffered disastrously negative real wages for many months, and may now be reaching the limit of how far they are prepared to reduce savings. ECB Chief Economist Lane is speaking, after ECB President Lagarde said the inflation “monster” needed to be hit on the head. A club is a fairly blunt weapon, and there is a risk that Lagarde knock out the labor market and household incomes while ignoring the profit margins behind inflation.

My question is - what tools the central banks and the governments can use to tame the profit led inflation?

As far as I can understand then the private bankers suggest just doing nothing. In any case (both in the monetary tightening and in the do-nothing approach) the reasoning is that consumers will exhaust savings (i.e. convert their savings into the profit of companies) and then the consumers will stop spending, will reduce demand side and the inflation problem will be solved.

But one can argue, that savings-exhaustion approach is not the socially fair solution that maximizes the total welfare. That is why one can hope that there are tools that targets exactly profit led inflation. I have my ideas about technological advancements, education and about labeling schemes and information schemes, e.g. opening up the biggest profit takers and their mechanisms. But certainly, there should be some literture which I am seeking in my question.

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  • $\begingroup$ Could you please provide reference to bankers suggesting "just doing nothing. In any case (both in the monetary tightening and in the do-nothing approach)" $\endgroup$
    – 1muflon1 ♦
    Mar 6 at 9:57
  • $\begingroup$ By "doing nothing" I meant no further base rate increases which are expected in Europe and US. I will not provide links (these as just regular macro outlooks by banks, e.g. Skandinavska Enskilda Bankenk SEB, etc.) but many bankers are cautious about further tightening. $\endgroup$
    – TomR
    Mar 6 at 12:05
  • $\begingroup$ "profit led inflation" seems a loaded phrase. There have recently been supply shocks, and possibly demand shocks, as well as tighter labour markets. It is unclear that any of these have been led by profit maximisation rather than causing excess profits in some sectors. $\endgroup$
    – Henry
    Mar 7 at 13:46
  • $\begingroup$ I have no illusions about the significant part of the humankind, it is certainly loaded, we just need to acknowledge that and take according measures. Just survival. $\endgroup$
    – TomR
    Mar 7 at 14:23

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Inflation can be either driven by supply or demand shocks (e.g. see Eickmeier & Hofman 2022 What drives inflation?). If you observe excess profits while there is inflation, it is likely that the inflation is being driven by demand shock which allows firms to raise prices and hence increase profits (with supply shocks firm's costs would raise). The profit itself does not drive inflation, demand does. Although research (see ibid) shows supply factors also drive some of the recent inflation it also empirically seems to be demand driven.

When it comes to demand driven inflation government can pursue tight monetary policy by increasing interest rate or reversing some of the monetary expansion done by QE when the bonds expire or some combination of both. So indeed monetary tightening is not just one of the tools, monetary tightening is the tool that can be used to fight inflation. In addition to that new research suggest that it might be good idea to have some degree of fiscal and monetary coordination, where monetary tightening is accompanied by fiscal tightening as well as opposed to the traditional view (e.g. see Cochrane 2021)

PS:

  • Socially fair solution, is not necessary or even usually, solution that maximizes total welfare. Those are different concepts.

  • Technological advancement or education are supply factors that can help with supply driven inflation but won't affect aggregate demand.

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  • $\begingroup$ I am sorry for my irony, but profit driven inflation can show that there is lack of management human resources or lack of capital and exactly two those things are the bottleneck now. Otherwise there would not be accumulation of the profits in the intermediaries, but demand would be passed thourgh entire value chain till the raw input factors. Initially (2022 Summer and Autumn) this was true - raw materials experienced surge of prices, but now this is not true at all (2023 Spring). $\endgroup$
    – TomR
    Mar 6 at 12:03
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    $\begingroup$ @TomR 1. when raw materials experience price increase that is usually due to factors that affect production so that would be supply driven inflation. 2. There is no reason why demand driven inflation would increase profits or prices of raw materials. Profits increase where there is market power. Raw materials are homogenous products usually with large number of producers and with some exceptions there is very little market power there. 3. Inflation is not caused by bad management at a firm level there is no credible research that would connect firm level management and inflation $\endgroup$
    – 1muflon1 ♦
    Mar 6 at 17:16
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    $\begingroup$ 4. also bad firm level management is inconsistent with firms being more profitable. Bad management would be a supply factor so that is quite inconsistent with firms somehow managing getting higher profit when they are bad at producing goods and services $\endgroup$
    – 1muflon1 ♦
    Mar 6 at 17:23
  • $\begingroup$ UBS comment of this morning ubs.com/global/en/wealth-management/insights/… clearly proves the gap how economists and bankers perceive this inflation and the what tools are necessary. While UBS bankers are sceptical about tightening effects on profit led inflation (they are using this loaded word), the economists and central bankers neglect this specific explanation and are going ahead with tightening. $\endgroup$
    – TomR
    Mar 8 at 8:07
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    $\begingroup$ @TomR UBS is some private investment fund. I would take all such comments with grain of salt, the same way as you should take comments of people like Peter Schiff with grain of salt (e.g. all the nonsense about gold standard Schiff is always promoting). That's an academic equivalent of basing research on something someone on street said $\endgroup$
    – 1muflon1 ♦
    Mar 8 at 10:56

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