Recently, there has been an increasing consensus in Europe and US that Greedflation is driving the rising cost of living rather than just Inflation.
GS III: Indian Economy
Dimensions of the Article:
- What is inflation — and disinflation, deflation and reflation?
- Understanding the Wage-Price Spiral
- About Greedflation
What is inflation — and disinflation, deflation and reflation?
- Inflation is the rate at which the general price level of goods and services in an economy rises.
- It is measured by the inflation rate, indicating the percentage increase in prices over a specific period.
- For example, if the inflation rate was 5% in June, it means prices increased by 5% compared to June of the previous year.
- Disinflation occurs when the rate of inflation slows down.
- It refers to a period when prices are still rising, but at a slower rate each month.
- For instance, if the inflation rate was 10% in April, 7% in May, and 5% in June, it represents a trend of disinflation.
- Deflation is the opposite of inflation.
- It occurs when the general price level of goods and services in an economy decreases.
- Deflation implies that prices are falling, leading to an increase in the purchasing power of money.
- For example, if prices in June were 5% lower than in June of the previous year, it signifies deflation.
- Reflation is an economic policy aimed at stimulating economic activity and reversing deflationary trends.
- It involves measures such as increased government spending or reduced interest rates.
- Reflationary policies are implemented following a period of deflation to boost consumer spending and investment.
Causes of Inflation:
- Occurs when prices increase due to rising input costs.
- For example, if the cost of raw materials, labor, or energy increases, businesses may pass on these higher costs to consumers by raising prices.
- Occurs when prices rise because of excess demand in the economy.
- If the demand for goods and services surpasses the available supply, sellers can increase prices to maximize profits.
Managing Excess Demand:
- If inflation is driven by excessive demand, central banks can raise interest rates.
- Higher interest rates make borrowing more expensive, reducing overall spending and demand in the economy.
- Addressing Cost Pressures:
- Even if inflation is caused by cost pressures, central banks may still raise interest rates.
- Although this does not directly address supply issues, it helps control overall demand and prevent further price increases.
Objective: Preventing the Wage-Price Spiral
- Central banks aim to prevent a phenomenon called the wage-price spiral.
- When prices rise, workers demand higher wages to maintain their purchasing power, leading to increased production costs for businesses.
- This cycle continues as businesses pass on higher costs to consumers, causing further price increases.
- By managing inflation through monetary policy, central banks aim to control this spiral and maintain price stability in the economy.
Understanding the Wage-Price Spiral
Worker Wage Demands and Increased Demand:
- When prices rise, workers naturally seek higher wages to maintain their purchasing power.
- However, higher wages without an increase in productivity only stimulate overall demand without boosting supply.
- This leads to a cycle where inflation surges further as workers and consumers have more money to spend, causing prices to rise.
Raising Interest Rates to Control Inflation:
- Central banks often raise interest rates as a measure to control the wage-price spiral and manage inflation.
- By making borrowing more expensive, higher interest rates aim to reduce overall spending and demand in the economy.
- However, this approach can also slow down economic activity and potentially result in job losses.
Factors Beyond Wage Increases:
Price Increases Due to Company Profits:
- In certain situations, price increases may not be solely driven by workers’ wage demands but also by companies seeking higher profits.
- For example, during natural disasters or pandemics, businesses like airlines may charge significantly higher prices for tickets.
- Sellers of essential goods and services may also raise prices sharply during crisis situations.
Input Cost Considerations:
- When input costs rise, businesses may need to raise their prices to sustain their operations.
- In such cases, higher sales in monetary terms do not necessarily translate to higher profits as input costs have also increased.
- This is a reasonable response to cost pressures and does not indicate corporate greed.
Supernormal Profits and Market Pricing:
- However, a crisis may reveal situations where businesses exploit the circumstances to make supernormal profits.
- Supernormal profits occur when the price mark-up far exceeds the increase in input costs.
- In some cases, businesses may not adjust market prices even when input prices fall, leading to higher inflation driven by corporate greed.
- Greedflation refers to a situation where inflation is driven by corporate greed rather than a wage-price spiral.
- It involves a Profit-Price Spiral, where companies exploit inflation by excessively raising prices to maximize profit margins, going beyond covering increased costs.
- This behavior further fuels inflation and is gaining recognition as a significant factor in developed countries like Europe and the US.
- Crises such as natural disasters or pandemics often lead to price surges as businesses pass on increased input costs to consumers.
- However, in some cases, businesses take advantage of the situation to generate excessive profits by significantly increasing price mark-ups.
- Greedflation disproportionately affects low-income and middle-class individuals, reducing their purchasing power and lowering their living standards.
- Meanwhile, it benefits the wealthy by increasing the value of their assets, widening the wealth gap and exacerbating income inequality.
- Excessive price increases and speculative behaviors driven by greed can create bubbles and unsustainable market conditions, making financial markets more vulnerable to crashes and crises, posing risks to overall economic stability.
- Inflationary pressures caused by greedflation can lead to divergent policies among countries, as each nation adopts different strategies to combat inflation, resulting in conflicting approaches.
- This can contribute to global imbalances, trade tensions, and geopolitical conflicts as countries seek to protect their interests and competitiveness.
Is Greedflation Happening in India?
- The net profits of listed companies in India have reached a record high.
- In March 2023, the net profits of Indian listed companies surged to Rs. 2.9 trillion.
- This figure is over 3.5 times the pre-pandemic average of Rs. 0.83 trillion, which was observed from December 2017 to December 2019.
- The significant increase in net profits indicates exceptional profit generation in the post-pandemic period.
Existence of Greedflation:
- Approximately 60% of the growth in net profit among Indian companies can be solely attributed to an increase in profit margins.
- The increase in sales contributed an additional 36% to the growth.
- The remaining percentage represents a bonus resulting from a combination of the two factors.
- These figures suggest the presence of greedflation in India, where companies are utilizing excessive profit margins to drive their net profits.
-Source: Indian Express