"Greedflation" and the Profits Equation

The assumption behind the "greedflation" thesis is that companies are choosing to squeeze volumes because they care more about unit margins than total profits. There are other possibilities.

Have executives made inflation worse by choosing to maximize profit margins at the expense of consumers?

When unwelcome inflation is accompanied by surging profits, it is only natural to suspect a causal connection; after all, the price of any good or service can be decomposed into its cost of production plus some markup. If rising markups were contributing to price spikes, policymakers might reasonably wonder if inflation could be tamed by prohibitions on excess profits—or even price controls. Similarly, investors might wonder if companies have finally found a way to hedge themselves from inflation risk.

However, even though this mechanism might explain what happened with specific industries or particular categories of goods and services at points in time over the past few years, “greedflation” alone cannot explain overall price trends since the start of the pandemic.¹

While the observed facts are consistent with several distinct theories, only some of those theories are consistent with the macroeconomic accounting identities that define what is logically possible. There are certain relationships that must always hold by definition: global spending must equal global income, financial asset accumulation must equal financial asset issuance, etc. These sorts of relationships constrain what could have happened if profits had not grown as much as they actually did.

As I have written before, profits could have grown by less, the workers’ share of output still has plenty of room to rise, and a balanced approach to disinflation should include both margin compression and slowing wage growth. But it is important to understand exactly what this would have meant—in particular, the implications for consumer spending. For that, we need to look at how profits fit into the national accounts.

Re-Arranging the Profits Equation

There are several ways to think about economy-wide profits, but I think the most straightforward one is to start from the premise that profits are the revenues earned by businesses that are not spent immediately on intermediate goods, labor, interest, dividends, taxes, or other costs. In other words, profits contribute to aggregate saving. As the Bureau of Economic Analysis’s handbook puts it:

Corporate profits, a widely used measure in the United States, is distributed to government (taxes on corporate income) and to shareholders (net dividends) or is retained (undistributed profits, which can be thought of as a measure of corporate saving).

Equivalently:

Pretax corporate profits =
Gross corporate saving + Net dividends paid + Corporate profit taxes
- Depreciation

By itself, this equation is not very informative, but two other identities can help us:

Corporate saving = Domestic saving - Noncorporate saving

Domestic saving - Domestic investment = Current account balance

Now we can re-write the initial identity as:

Profits after tax =
Gross domestic investment + Current account balance
- (Gross personal saving + Gross government saving)
+ Dividends paid to Americans + Dividends paid to foreigners
- Dividends received from foreign subsidiaries - Depreciation

This is the Levy profits equation. But what determines “personal saving” and “government saving”?