Blaming company behavior for the structural outburst of inflation increasingly sounds like ideological rather than empirical argumentation. In the meantime, the IMF went out of its way to signal the possible need to pause in the fight against inflation. That would be a big mistake, certainly for the Eurozone.

It was almost as amusing as it was interesting. Last week, a most lively exchange developed on Twitter between Olivier Malay, an economist teaching at Brussels University (ULB), and Geert Langenus, member of the research department at the Belgian central bank (NBB). The exchange between the two was about whether or not “greedflation” is, or was, a reality. Greedflation is the notion that greedy companies have taken advantage of recent turmoil to beef up their profit margins. By doing so they have been, so the argument goes, the major driver behind the inflation outbreak that started in 2021. The political left has elevated greedflation to its main speaking point on the inflation issue.

Olivier Malay was vocally supportive of the greedflation thesis, whereas Geert Langenus argued that, on the basis of Belgian evidence, there was no trace of this phenomenon. The exchange between the two - that you find HERE - became quite painful for Malay, as Langenus calmly and meticulously shot down each and every argument developed by the ULB economist in favor of the greedflation hypothesis. Greedflation as contributor to Belgian inflation is now anything short of dead and buried. Olivier Malay withdrew from the discussion with the message “thank you for the information”. Let’s hope he makes good use of it.

Two further remarks on the greedflation debate are pertinent. First, the data on profit margins should be handled with care. Let me give one example. The indicator most used in this context is EBITDA (“Earnings Before Interest, Taxes, Depreciation and Amortization). The key element is “interest”. Until around mid-2022, interest costs for companies were very low. Once central banks woke up to the inflation problem and started hiking policy rates, market interest rates escalated quickly too. Looking at EBITDA as the measure of profit margins without explicitly recognizing this fundamental U-turn in interest burdens gives a misleading impression.

My second remark is more fundamental. Let us for the sake of the argument accept that the corporate sector has been pushing up their prices more than the evolution of their cost base necessitated (action that translates in higher profit margins). It is important to remember that during the second half of 2021, when the uptick in inflation was becoming very visible, and deep into 2022, most central bankers kept arguing that inflation was “transitory” and that there was no need for central banks to make monetary policy more restrictive. The Fed changed course in March 2022, but the ECB waited even a few months more until July to start taking real restrictive action.

Just try to imagine what kind of impression the situation just described made in corporate board rooms, where the impact of inflation had been apparent for more many months. Prices of energy, raw materials and many intermediate goods were clearly on the rise in circumstances that seemed anything but “transitory”. Nevertheless, most central bankers kept talking about “transitory” inflation and acted accordingly, i.e., they stood aside and left monetary policy unchanged. The doubt about central banks’ preparedness to tackle inflation grew hand over hand.

Can it be a surprise in those circumstances that companies started to change their pricing behavior pro-actively? If you see a storm coming you seek shelter before the storm breaks. The complacent attitude of central banks vis-à-vis the developing inflation storm obliged companies to act to protect profit margins and competitiveness. It would even have been irresponsible on the side of corporate leadership not to act and not to change prices pro-actively. 

At the ECB’s recent Forum on Central Banking 2023 in Sintra, Portugal, ECB president Christine Lagarde, commenting on the actions companies had taken to protect their profit margins, noted that “the intensity of this reaction was unusual”. There can only be two explanations for this “unusualness” but they are not mutually exclusive. The first is the one I just developed earlier in this blog: companies acted in the way they did because they were scared by the lack of action on the part of the central banks and feared that the inflation outburst would really get out of hand. The second one is that elements of monopoly and cartelization allowed some companies in some sectors to “go for it” in a concerted way. If there is evidence of the latter, which there manifestly is not in the Belgian case (see the Malay-Langenus exchange), then competition authorities must act. You don’t cure monopolistic behavior with higher taxes, as large parts of the political left is now demanding. Monopolists and cartel members smilingly increase their prices in tune with the cost of higher taxation.      

At the same forum in Sintra the most surprising comments came from the IMF’s deputy managing director, formerly the institution’s chief economist, Gita Gopinath. She declared that central banks will need to accept the “uncomfortable truth” that we may be about to enter into a situation in which the reality of a longer period of inflation above 2% must be accepted to avoid a financial and/or debt crisis. This statement was widely interpreted as a call for halting policy rate increases. In the US a call for keeping policy rates steady has limited legitimacy, while it has absolutely none for the Eurozone.

This statement of Gopinath’s is most extraordinary given that only a few weeks ago the same IMF warned of “persistently high inflation” in the eurozone and called for rate raises over a “sustained period”. This kind of backpedaling by an authoritative organization such as the IMF is highly unproductive. It is even more so when proclaimed at a moment when, despite headline inflation coming down in the euro area, core inflation keeps on climbing. The fight against inflation is not over by any means, as Lagarde underlined very explicitly at the Sintra forum. Lagarde warned that “the inflation process has become more persistent” and concluded that “our job is not done. Barring a material change to the outlook, we will continue to increase rates in July”. Bundesbank president Joachim Nagel made no reference whatsoever to changes to the outlook when he declared that it would be “a first-order error” to stop raising rates even if headline inflation keeps falling in the coming months.      

Of course, financial stability and debt sustainability are at risk today because, partly due to the persistently expansionary monetary policies of the past two decades, the world is now massively over-leveraged and over-indebted. But calling off the battle against inflation to deal with that regretful legacy of past policy misbehavior would be a monumental mistake. It would once more signal to a limited group of private agents – would speculators be a more appropriate term? – that the show can go on, that extreme leverage remains a promising venue for extraordinary profits based on purely financial constructions. Even worse, should the show hit the buffers, the signal remains that monetary and budgetary authorities will come to the rescue when bubbles burst and losses and tears are everywhere. 

Public authorities should deal with financial and debt-related issues by using policy tools that do not infringe on the fight against inflation. For debt-related issues, for example, this means that national governments take responsibility for budgetary policies in line with the need to reduce deficits and debt ratios.

As far as financial stability is concerned, private losses that are not systemic should just remain private. Those who profited from the bubbles to which they contributed should be left on their own to assume the losses too. Full stop. Systemic institutions that risk to go down because of financial turmoil should be supported, but in such a way that the shareholders of these institutions take the full hit of the losses, not the taxpayers. If that means temporary nationalization, so be it. All this can and should be done without backpedaling on the restrictive stance of monetary policy.