An Explanation For Inflation

CounterPunch Radio has an excellent rant/explanation of the current “supply chain” crisis and inflation.

This week Eric welcomes back to CounterPunch economist, author, and scholar Richard Wolff to discuss the state of the US and global economy. Prof. Wolff provides his analysis of the inflation issue and what banks, corporations, and the US Government can and should (but probably won’t) do. Eric and Richard also discuss unemployment, interest rates, the crypto collapse, the future of the US dollar as a global reserve currency, and much more. Don’t miss the latest CounterPunch Radio! More




  1. flex says

    While I wouldn’t call this podcast wrong, I would say that it is somewhat misleading. Particularly to people who listen to only the first ten minutes and then think they have a good understanding of inflation.

    For example, Prof. Wolff talks about how Nixon put price controls in place to stop inflation. And inflation stopped immediately. Of course it would. Inflation is measured by tracking the change of prices over time. If the prices don’t change, for whatever reason, inflation doesn’t occur no matter what happens to demand or supply of goods or currency. Prof. Wolff is being a little disingenuous when he suggests price controls, for I’m certain that he knows full well that applying price controls would actually make it harder to track the national economy because one of the major tools used to measure economic activity would be eliminated.

    Inflation has a fairly precise definition in economics, and the causes in a general sense are pretty well known. Richard Wolff appears to know these causes, but also seems to be attributing the current inflation to one cause without looking at the fairly complex details about how inflation occurs even under his explanation, he also dismisses alternative explanations without good evidence, and doesn’t explain why quantifying inflation can be difficult. This may be due to lack of time, so I can’t really fault him for that, but again I feel the podcast is misleading because of it.

    First off, inflation (or deflation) is really, at it’s core, a tracking of how prices change over time. This is easy to grasp for a single good, but it gets very complex very quickly when it’s expanded to all goods in an economy. As an example, if you purchase a loaf of bread for 1 USD one week, and next week you purchase that same loaf for 1.1 USD, you can say the price of the loaf inflated by 10%, or that the loaf saw 10% inflation in a week. The explanation Prof. Wolff gives for this increase in prices is greed, i.e. the producer of the loaf of bread wanted to make more profit and thinks they will sell as much bread as before with a higher price. Prof. Wolff is not wrong, but there are a lot of reasons other than greed why the producer of that loaf of bread may raise the price.

    Now a person who’s just taken Econ 101 will probably say that the reason the seller raised the prices was due to increased demand. The idea in economic studies is that the best way to understand economics is to hold one factor constant and adjust another factor, the argument is that if demand goes up, but supply remains the same, the price increases. I.e. more people competing for the same good means the seller of that good can still sell all their product at a higher price and make more profit. However, demand for bread is fairly inelastic, i.e. the same amount of bread will be purchased regardless of price (at least to a point). Further, suppliers of bread rarely sell all the bread they produce, a lot of bread is discarded, either thrown away or in some cases fed to farm animals. Using supply and demand curves to provide reasons why there is inflation in the price of bread doesn’t really apply well. There is more supply than needed. So is Prof. Wolff right, and the reason the price of bread has gone up is due to the makers of bread wanting to increase their profit? Not necessarily.

    Another factor to consider is profit margin, which is really about setting the selling price of a good against the cost to produce it. If the cost for the bread maker is 0.90 USD/loaf to get the bread to the store, then the profit margin is about 11%. But getting the bread to the store is a complex process. In a simplified version it involves buying the flour, water, and fuel. It also involves building and maintaining equipment, including yeast cultures, mixing vats, and ovens. Along with ancillary equipment like drying racks, forming molds, tools to maintain all these. It also involves quality testing equipment, to ensure safety and consistency. Then there is rent for the facility, in the forms of actual rents and property taxes. There is also very likely bank loans to repay with interest. Finally, there are all the people working at all these jobs. A small bakery, which makes a few hundred loaves of bread a day, can be managed by a couple people. One of the larger bread makers may hire hundreds. There are significant costs beyond just salaries for these people, collecting for SS and health care, and there are often people who are hired to manage those costs.

    All of these costs add up. An 11% margin is good as an example, but in the manufacturing of physical goods most margins are in the 3-5% range. That 3-5% is profit, after all the costs are accounted for, which isn’t to be sneezed at. If a company sells 1,000,000 USD of bread in a year, that is 50,000 USD profit, which can be used to expand plant, put into a fund against bad years, or just handed to the CEO. (Note, the salary of the CEO would be part of the pre-profit expenses.)

    But if the cost of any of the above input requirements goes up, say the price of wheat goes up by 10%, the profits go down. If a lot of the inputs go up at once, then it can rapidly occur that the company is no longer profitable. This occurs without any desire from the company to make more profit. There are things the companies can do to continue to produce the goods they make; like stop making investments in growth, dipping into their reserves to cover costs, or cutting compensation (including the CEO/board). These can work for awhile. Companies can also raise their prices to pass the increased costs onto the consumers.

    As mentioned above, inflation is calculated by tracking the change of prices. So if companies do raise their prices, we get inflation. But there are many reasons a company may change their price. An inflation index, which is really what we mean when we talk about the inflation within a country, is an aggregate. It’s the measurement of the changes in prices of a selection of goods sold in the country. Not all goods, and you can also get inflation rates for different categories, like entertainment or clothing if you want. Some prices go down, some go up, but as an aggregate, it gives an indication of how much prices are changing. It is an incredibly complex calculation to make, trying to aggregate many of the prices in an economy, and because of the number of factors it can be confusing.

    So what is causing the current inflation? There are several possible factors, and again Prof. Wolff isn’t wrong, but I don’t think he is clear. Prof. Wolff says the cause of inflation is profit-seeking. That is true without being very enlightening. Prof. Wolff says inflation is caused by the owners of the means of production needing to re-capture lost profits from previous years. That is also true, but misleading. Prof. Wolff dismisses supply-chain issues as not important to understand the reason for inflation, this is incorrect. As discussed above, any increased costs of production can be managed in several ways, one of which is to increase the price. Supply chain issues directly impact the costs of production. This occurs even if the price of the good being sold to the producer stays the same. If a factory cannot produce parts for a month because the supply chain is disrupted, there are still costs to the owners of that factory, even if the owners put their employees on unpaid leave the owners need to pay rent, taxes, utilities, and maintenance. Further, many factories are trying to avoid unpaid leave as much as possible for their employees simply because their employees may not return if they do so. A supply chain disruption will generate a negative profit for a period of time. Again, there are a number of ways to balance this loss, and raising prices is a very common strategy. But some of the alternatives could bankrupt the company.

    Again, inflation is measured by tracking the change of end consumer prices over time. And for any specific producer of a good, there are other companies providing the products needed to make the good as well as labor needed to manufacture it, and any change in the costs of those inputs can result in a change in the cost of the end consumer price.

    Some factors which can cause inflation:
    Transportation costs going up – This will happen as energy costs go up.
    Higher standards of living – As less-developed countries improve working conditions, wages, etc., manufacturing costs in those countries will rise, resulting in the costs of imported raw materials/finished goods going up, driving up prices.
    Supply chain disruptions – This causes scarcity and reduced profit, both of which can drive up prices.
    Raw material costs – This can be scarcity, like palladium for electronic components, or increased costs, as an example a government may require companies who extract raw materials to start paying for the externalities they didn’t used to.
    Financial costs – If a company has to repay loans, and their profits go down for other reasons they have an incentive to raise prices.
    Increased supply of currency – In the aggregate, more currency in an economy will also create pressure for higher prices. This is extensively discussed in Econ 101, and is generally true. The underlying concept is that when people have more money to spend they demand more goods, and the increased demand (with a fixed supply) will slide the prices up. Note that if the demand and supply are both somewhat elastic, this may not have any impact on price. Regrettably, Econ 101 rarely mentions that the basic supply/demand curves are models which can be useful to understand past economic performance but is rarely useful to predict future economic performance. That is, they are useful to understand the underlying theories, but useless as practical tools.
    Greed – The explanation Prof. Wolff suggests.

    So what can be done?

    First, note that in the factors I list of inflationary pressures, some of them result in a net increase in happiness, like higher wages and/or standards of living, or forcing companies to pay for externalities which they were not previously doing. Frankly, I am happy paying a little extra for sustainable production or helping to raise the standard of living in a less-developed country. I only wish I felt I could trust all the companies who claim they are doing so.

    Second, governments should provide a strong social safety net. That is; universal health care, some sort of basic level of income, maintain reserves of food (and fuel to distribute food), widely distribute energy sources so local disturbances can be managed, build/maintain an extensive transportation network to rapidly meet disasters, etc. Taking some of the factors which do impact prices (e.g. worker health care costs), away from companies means there are less reasons why companies may want/need to raise prices.

    Third, society should put incentives and dis-incentives in place to reduce greed and environmental degradation. If moral suasion doesn’t work then government regulation is needed (note: moral suasion has not worked). These can include incentives; for example, the elimination of property taxes on inventory or partially finished goods. A VAT reduces the incentive for Just-In-Time logistics which is particularly vulnerable to shortages. There are a number of possible incentives.

    As an example of a dis-incentive, heavy fines for companies and personal liability for company boards which knowingly violate regulations. If a company board knows that, for example, their company may be nationalized or dissolved and they will be held personally liable for decisions they make in the name of the company, that may change some behavior. Limitations to liability should be restricted to accidental problems or problems which arise beyond the control of the officers of the company. E.g. if a plant burns down because of a lightning strike, the CEO shouldn’t have their personal wealth garnished to pay for re-building (even if it would be enjoyable to watch). However, if that CEO was told that some equipment needed repair, and they made the decision to not repair it and the plant burned because of it, the CEO should have some liability for making a decision which caused the destruction of the plant. An LLC should not be a get-out-of-jail-free card.

    So let’s discuss price controls for a moment, Prof. Wolff’s recommended solution. The problem with price controls is where does a government stop. The only way it works is by fixing the price of everything, from raw materials to labor to finished goods. If the government puts price controls on labor and finished goods, then the government must also be prepared to give money to companies who would go bankrupt because the materials the company purchases goes up, or the cost of transportation, or energy goes up. Price controls push the government into the role of decided which companies are winners or losers, and put pressure to nationalize companies. Enacting price controls on a long term (>2 years) basis requires a complete command economy, which results in the growth of a secondary, uncontrolled, economy without any regulation. We’ve seen that in every command economy which has been tried, from the French after the French Revolution, to the short period during and after WWII in the US. Not to mention the USSR, People’s Republic of China, or Great Britain. There are times when price controls are needed, but they should be a short-term. My read on the current inflationary pressures is that some of it could be improved with price controls, that would alleviate some of the supply shocks, but the underlying causes of inflation are still there and as soon as the price controls are removed there would be a spike in prices (i.e. inflation). So using price controls is not a tactic I would recommend at this time. Instead, I recommend my other suggestions above.

    Finally, and just as a note because I think it clearly reveals where Prof. Wolff is coming from, I was a bit taken aback at the end of the interview when he said that most people in the world want Russia to take over Ukraine. Now I admit that the news coverage I’ve read hasn’t provided much support for that alternative view, so maybe I’m missing some news reports. But it seems to me that the Ukrainians are against Russia occupying their country. As far as I can see, if the Ukrainians are fighting to remain an independent nation, then the opinions of the rest of the world are rather moot.

    This comment took me some hours to compose, as you can probably tell by the length. Since Prof. Wolff was probably edited down to an hour show from what was likely a conversation which took a few hours, I am not going to suggest that he isn’t aware of everything I wrote and he may have even mentioned it in the interview. Prof. Wolff is an educated person, and I doubt that anything I wrote is new to him. But it became clear to me that Prof. Wolff is in favor of abandoning capitalism for a command economy. For a number of reasons I prefer a highly-regulated capitalism model, and I think that is where Prof. Wolff and I would disagree. Because we are approaching the issue of inflation from different opinions of which economic model would provide the greatest benefit to our world, we have different suggestions to make.

    The TL/DR version of the above screed is:

    Interesting video, Prof. Wolff made some nice points, but I don’t agree with a good bit of it and I fear that people who watch it uncritically will get a misleading impression about a very controversial area of economics.

  2. tuatara says

    Hey, Marcus!
    I hope you are okay and just busy with your other stuff, but in light of your recent TIA scare, I am worried about the fact that you haven’t posted anything in a while and haven’t commented recently on any of the other usual haunts.
    Are you okay?
    Really hoping to see the sesults from your new forge project, or anything else from you.

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