Inflation has become something of a buzzword in 2023, but many people who use it don’t fully understand why it happens, how it’s controlled, and the deep impact it has — Not just on the economy, but also on ordinary, everyday, working class people. Once we start to understand more about how inflation works, we can begin to recognize how much of today’s increased pricing of goods and services is less a product of inflation, and more so a product of corporate greed and profit maximization.
So what is inflation?
Inflation can be described as the persistent increase in the prices of goods and services over time. While inflation affects the economy at large, it tends to hit the working class the hardest. This is because they are the ones who rely on their income to meet their day-to-day needs and expenses. Contrast this to how very wealthy people can afford to concentrate and grow their wealth at an exponential rate, without having to worry about paying rent or putting food on the table.
On the other hand, for the wealthy inflation can actually be a good thing. This is because they often hold assets that appreciate in value during inflationary periods. Real estate, stocks, and commodities are all examples of assets that typically appreciate in value as prices rise. Additionally, the wealthy often have the means to invest in these assets, which can help them to grow their wealth and maintain their purchasing power. They are also more often financially prepared for periods of recession and job market crashes, and can therefore take advantage of some of these changes in the economic climate.
But for most people, inflation simply erodes the purchasing power of their money. As the prices of goods and services increase, the value of money decreases. This means that working class consumers are forced to spend more money to purchase the same goods and services that they used to buy for less. This can be especially challenging for those working low-income jobs who struggle to make ends meet.
And this disparity between the 99% and the 1% is actually exacerbated. Not only does inflation force people to spend more money on cost of living needs — inflation also siphons wealth from the working class in several other ways. It’s kind of a double whammy.
Firstly, inflation can lead to higher interest rates. When prices increase, the economy responds by tightening monetary policy to prevent inflation from spiraling out of control. The central bank may raise interest rates to reduce the amount of money circulating in the economy. This means that folks who have mortgages, credit card debt, student loans, etc. will have to pay even more interest on their loans. This ‘quantitative tightening’, as it’s called, exponentially increases the amount of debt working class people must pay over time, and it’s not an uncommon for these debts to double and even triple when all is said and done. In the end, borrowers are left with less disposable income to use on other essential expenses.
Secondly, inflation can lead to stagnant wages. When prices go up, employers may be reluctant to increase wages, as they would have to spend more money to maintain the same standard of living for their employees. In these situations, working people experience higher costs of living, while relying on a source of income that can’t keep pace with inflation. This can lead to lower standards of living for workers who are already struggling to to get by.
Thirdly, inflation can lead to decreased savings. When prices increase, the working class may be forced to spend more money on essentials like food and housing, leaving them with less money to save. This can impact their ability to build up wealth and plan for their future. It can also mean that they are more vulnerable to economic shocks, such as job loss or expensive medical emergencies.
And speaking of savings, lastly, inflation can cause people’s savings to dwindle to nothing over time. This is due to the decreased spending power we already talked about, and which impact savings accounts especially hard; unlike investments, one’s savings don’t appreciate over time, and therefore get crushed by the effects of inflation.
To wrap up part one of a two part analysis, inflation can have a devastating impact on the working class. It can erode the purchasing power of money, increase interest rates on loans, lead to stagnant wages, and reduce saving. While inflation affects everyone in the economy, it is those who rely on their income to meet their basic needs who suffer the most.
Now here’s where things get dark.
We’ve all heard the narrative that measures taken by governments in response to Covid-19 led to increased inflation, and that supply chain inefficiencies due to Covid lockdowns increased the prices of many consumer goods and products. However, there’s more to this story than most people know.
Figures released in May by the European Union’s statistics agency showed consumer prices in the eurozone were 7.0% higher than a year earlier in April, a pickup from March and more than three times the European Central Bank’s target. However, the core rate of inflation — which excludes food and energy prices — edged down to 5.6% in April from a record high of 5.7% in March.
Inflation rates also remained uncomfortably high in the U.S. and many other parts of the world, despite interest-rate rises that have gone further and been delivered more quickly than at any time since the 1980s.
While it’s true that the supply-chain disruptions caused by Covid-19 and the energy, food, and raw material bottlenecks following Russia’s invasion of Ukraine have certainly pushed costs higher, there are numerous signs suggesting that many corporations are doing more than just covering these increased production costs. The increased pricing of goods and services we’re seeing just don’t match up with the inflation story.
According to economists at the ECB, businesses have been padding their profits, and allegedly this has been a bigger factor in fueling inflation during the second half of last year than rising median wages were. According to Jan Philipp Jenisch, chief executive of construction-materials maker Holcim, “We [have been] in that inflationary environment already for almost two years now…We have done the pricing in a very proactive way, so that our results aren’t suffering. On the contrary, they are improving the margins.”
Consumer spending has held up relatively well so far, despite inflation, but experts say we’re approaching an inflection point. WSJ’s Sharon Terlep explains the role ‘elasticity’ plays in a company’s decision on whether to raise prices. One puzzle in all of this is why consumers have played ball. Usually economists would expect any business that raised its prices to lose a significant portion of customers to competitors that don’t.
But these aren’t normal times. In rare situations — such as an economy’s reopening after a pandemic — widespread knowledge that costs are rising allows businesses to raise their prices knowing that their competitors will act in the same way, according to a paper by Isabella Weber, assistant professor of economics at the University of Massachusetts, Amherst. This is a pattern that has played out in an analysis of recent corporate earning calls, in which executives at U.S. businesses have presented their financial results to analysts.
“We do have to think about pricing differently,” said Ms. Weber. “A cost shock, or bottlenecks can create an implicit agreement among firms that raise their prices, so they can expect others to act likewise.”
Consumers have also been unusually willing to accept higher prices lately. Paul Donovan, chief economist at UBS Global Wealth Management, said businesses are betting that consumers will go along, since they know about supply chain bottlenecks and increased inflation, as reported by many media outlets. Corporations are using this as a scapegoat to increase their profits, and consumers are going along with it. “They [corporations] are confident that they can convince consumers that the increased pricing isn’t their fault, and it won’t damage their brand,” Mr. Donovan said.
The latest round of earning calls by large consumer-facing companies underlined that. In May, 2023, food and health company Nestlé said it had boosted sales by 5.6% in the first three months of the year, despite raising its prices by 9.8% — its CEO said the company was simply matching cost increases over the previous two years. Elsewhere, the desire to boost margins, rather than just cover increased costs, appears to be one reason why food prices have continued to rise rapidly in Europe.
Much of the surge in food prices since the middle of last year stem from higher costs — particularly for energy — since most food production is quite energy-intensive. However, economists at insurance company Allianz have calculated that about 10% of the rise reflects the search for a higher corporate profit limit. They suggest this is likely, since key parts of the food-supply chain are dominated by a small number of firms. “There is not enough competition in the food sector, especially in distribution,” said Ludovic Subran, chief economist at Allianz.
But not all businesses are opportunistically boosting their margins, and in her paper Ms. Weber said that when some do, it can cause problems for others that are closer to the final consumer and are at greatest risk of facing a backlash. Over recent months, Germany’s largest retailer, Edeka, has complained about the pricing behavior of its suppliers of branded goods, and has stopped stocking some of their products. “We call on the branded-products industry to live up to its responsibility and stop artificially driving up inflation,” said Edeka’s CEO Markus Mosa.
There are some signs that food-price inflation is starting to slow. In France, food prices were 14.9% higher in April than a year earlier, a slowdown from 15.9% in March. In Germany, food inflation slowed to 17.2% from 22.3%. But the British Retail Consortium, a group that represents U.K. stores, said food inflation accelerated in April to hit a record high.
But in recent earnings calls, some executives said consumers were becoming more resistant to price rises. “We’ve made several adjustments to price gaps — not just versus private label — but versus branded competition as we’ve gone through this period of pricing, and we need to continue to be sensitive to that,” said Jon Moeller, the company’s CEO.
For Mr. Donovan at UBS, the period of profit-driven inflation might be coming to an end, in part because of rising public scrutiny. “We are probably at a point where companies may be reassessing whether to push this,” he said. “A reputation for being poor value for money stays for a long time.” A reputation for price gouging consumers and falsely blaming it on inflation lasts even longer. It may be time for working class people to remind these corporations who it is that actually keeps them in business.