fbpx

Greed Doesn’t Drive Inflation, Monetary Policy Does

Inflation is on the rise in the United States. With it, there are politicians now arguing that "greedy businessmen" are to blame for it. This is not only a misleading notion but also a dangerous one, as it could end up leading to policies as destructive as the ones implemented in countries like Venezuela.

If 2020 was the year of the pandemic, 2021 was the year of the return of inflation. In 2021, consumer prices for all items rose by 7 percent in the United States—the largest yearly increase since 1981.

Most economists explain the rise in inflation by pointing out the role of Biden’s stimulus program as well as the supply-side disruption produced by COVID lockdowns. But other academics and politicians are propagating a misleading and dangerous idea.

They claim that inflation is not a monetary phenomenon at all. Instead, they believe that businessmen are to blame for the rise in inflation. Massachusetts Senator Elizabeth Warren, for example, argues that the rise in inflation is nothing more than the result of “corporate greed.” In a public letter Warren sent to the CEOs of Kroger, Albertsons, and Publix, she blamed their companies for “passing costs on the consumer to preserve their pandemic gains.”

Your company, and the other major grocers who reaped the benefits of a turbulent 2020, appear to be passing costs on to consumers to preserve your pandemic gains, and even taking advantage of inflation to add greater burdens.

Your companies had a choice: They could have retained lower prices for consumers and properly protected and compensated their workers or granted massive payouts to top executives and investors. It is disappointing that you chose not to put your customers and workers first.

Most economists reject the idea that greed drives inflation as nonsensical. But the problem is that if Warren and others convince the public that greedy businesses are to blame, she and other politicians will be empowered to regulate and punish businesses without actually addressing the underlying causes of inflation (i.e., increases in the money supply).

It’s worrisome that calls for price controls are beginning to emerge in the United States. For instance, Isabella Weber, an economics professor at the University of Massachusetts, wrote in The Guardian that the United States needs a “systematic consideration of strategic price controls as a tool in the broader policy response to the enormous macroeconomic challenges.”

Some scholars have even argued that rationing is necessary to avoid shortages. Rebecca Spang, a historian at Indiana University, recently said: “If you try to have price controls without rationing, you end up with shortages, you end up with purveyors pulling their goods from the market.”

Inflation is never caused by either greed or any other business activity. We need to make sure that people do not fall for those misleading narratives. If we fail to do so, then the United States runs the risk of repeating the same mistakes that my country did a decade ago—the very same mistakes that caused the worst humanitarian crisis in the history of the Americas.

A Cautionary Tale

Politicians and academics scapegoating businesses for inflation is exactly what happened in my own country, Venezuela. In the last decade, the idea that businessmen cause inflation led to a series of heavy regulations on business, including price controls. These controls ended up destroying the market mechanisms of the Venezuelan economy and caused chronic shortages of food and medicines. These policies laid the groundwork for Venezuela’s current humanitarian crisis.

How can a country so rich in natural resources—so wealthy in oil—end up so badly? My answer is always that Venezuela did not fail because of bad luck, nor even because of bad politicians. It goes deeper than that. My country failed because of the ideas its citizens held. Everything else is nothing more than a consequence of this terrible fact—from the leaders that we elected to the policies that they implemented.

A few of the detrimental ideas Venezuelans embraced were that presidents need almost unlimited powers, that expanding the supreme court was necessary, and that rewriting the country’s constitutions was not such a bad idea, which is why the country voted for these things in 1999.

 

Additionally, anti-business attitudes spread throughout the country starting in the 2000s. Coupled with the political ideas mentioned above, these attitudes enabled the late president Hugo Chavez to build his revolution. Chavez regularly denounced wealth and free markets while praising socialism. He said things like: “Being rich is bad, it is inhuman. I say so and I condemn the rich.” And: “Capitalism is the way of the devil and exploitation. If you really want to look at things through the eyes of Jesus Christ—who I think was the first socialist—only socialism can really create a genuine society.” And: “I have always said, heard, that it would not be strange that there had been civilization on Mars, but maybe capitalism arrived there, imperialism arrived and finished off the planet.”

These anti-business ideas, embraced widely by Venezuelans and propounded by Chavez, led to the economic policies that propelled Venezuela into the worst economic collapse in the western hemisphere’s modern history. Venezuela imposed tight currency controls to allegedly avoid capital flights to the United States (savings leaving the country), widespread nationalization of businesses (from sectors like farming to banking, energy, and others), and large state entities created to run all those sectors that were previously held by private organizations.

As I wrote in Public Discourse back in August 2020, the Venezuelan economic model could be summarized as a system that substitutes central planning for virtually all market mechanisms. I explained:

The Venezuelan state controls virtually all the country’s means of production, from basic industries like oil and aluminum, to agriculture, food distribution, telecommunications, and most other economic sectors. Moreover, through tight price controls and production quotas, the state strictly regulates those parts of the economy that are owned by the private sector. As such, the Venezuelan economy is doomed to low levels of investment, productivity, employment, and income.

Price Regulations

Thus far, we’ve seen that Venezuelans’ embrace of a powerful central government combined with their anti-business attitudes laid the groundwork for Chavez to enact aggressive, devastating policies that led to the economy’s downfall. Among those policies were price controls, which began in the 2000s and played a part in the country’s eventual economic collapse. The government claimed price controls would counteract the “greed” of businesspeople—whom Chavez blamed for the country’s increased inflation rate. He even labeled them “enemies of the country.” Chavez said: “The Venezuelan Federation of Chambers of Commerce has become one of the biggest obstacles to the development of the country. I declare you enemies of the country.”

At first, the Venezuelan government only fixed the prices of certain goods and services that they considered essential, from services like electricity, to food like milk, rice, and beans. Then, as Venezuela’s inflation rate kept rising, the price controls spread to the whole economy. By 2013, the Venezuelan government ended up establishing a 30-percent nominal earnings margin for all goods and services.

This decision ended up destroying Venezuela’s markets, as a 30-percent earnings margin was not enough for businesses to sell their products with a profit, partly because the country’s inflation rate was significantly higher than 30 percent. And as a result, most businesses declared bankruptcy and stopped operations.

This process further increased Venezuela’s already high inflation rate. It ultimately resulted in Venezuela’s nationwide chronic shortages of food and medicine, which became the basis of its unprecedented humanitarian crisis.

Inflation and Stimulus

Whether in Venezuela or in the United States, economics as a discipline tends to involve ongoing debate. For example, when discussing the issue of inflation, many economists debate how much of America’s current inflation rate is transitory or permanent.

Nevertheless, economists almost universally agree about what causes inflation. There is virtually no debate there.

“When more people want to buy things than companies are capable of making, prices go up. That’s just the law of supply and demand,” said Jason Furman, who served as Obama’s main economic advisor. “Companies always want to maximize their profits . . . I don’t think they’re doing it any more this year than any other year.”

What Furman is saying is that America is experiencing high inflation not because corporations suddenly became greedier. Rather, inflation is here because there’s been an abrupt rise in aggregate demand that surpassed the economy’s capacity. So, the key question is: why is the American economy experiencing an abrupt rise in aggregate demand? The answer is simple: the size of the stimulus program pushed by the Biden administration.

If we add Biden’s $2.5 trillion stimulus program to Trump’s $900 billion program at the end of his tenure, then the total government stimulus to the U.S. economy reached the $3.4 trillion mark. A stimulus program of that magnitude represents close to 15 percent of the United States’ gross domestic product, making it comparable only to the spending program that the U.S. government had during World War II.

 

The magnitude of the stimulus program is more than three times the economic output that was lost due to the pandemic. In other words, a stimulus program meant to compensate for the shock of the pandemic would have only been roughly a trillion dollars. For this reason, a year ago, economists Larry Summers and Olivier Blanchard argued that the stimulus program would be inflationary. According to Blanchard, the stimulus spending would place aggregate demand at 14 percent above the productive capacity of the American economy.

Just this month, Summers wrote the following:

Macroeconomic policies that push demand well past the economy’s capacity, such as those we have pursued over the past year, do not just lead to inflation but rather to increasing inflation—with the inflation rate accelerating for as long as the economy overheated.

Just as driving 100 mph is not the fastest way to get from Point A to Point B because it raises the risk of an accident or being stopped by police, maximum economic stimulus is not the way to maximize employment, living standards or gross domestic product over time.

This is why, for economists, the driver of inflation is crystal clear. It is not a sudden spike in corporations’ greed, as Senator Warren suggests. Instead, it is the natural consequence of injecting money into the economy at a rate beyond its productive capacity.

Getting Inflation under Control

Similarly, most economists agree on the policies that the American economy needs to put inflation under control. To lower the rate of inflation, economists do not propose the imposition of price controls—because doing so would lead to shortages, as I mentioned above.

So, what should the Federal Reserve do?

To curb America’s rising inflation, the Federal Reserve must adopt a contractionary monetary policy. That is, it needs to reduce the money supply by increasing the country’s interest rate. This is often achieved by increasing the so-called Fed Funds Rate, which is the rate at which financial institutions borrow money from the Federal Reserve.

When the Fed increases this rate, banks also have to increase their rates. This results in fewer people borrowing money from banks, which decreases aggregate demand, thus “cooling off” the economy. Acting in this manner is important. Inflation hits the lower and middle classes the most. They are the ones who do not have stocks or other assets to mitigate the effects of inflation on their savings. They are also the ones who rely on fixed salaries to maintain their quality of life, which keeps becoming more expensive as the months go by. And overall, they are the ones who always end up paying the bill in case inflation runs out of control.

This is why, instead of doing them any favors, huge governmental payouts are among the worst policies to alleviate poverty. If we really want to have a strong middle class, we have to stop believing the idea that growth and progress can be achieved by subsidizing people’s consumption through fiscal support rather than strengthening their own productive capacities.

But when it’s too late and prices keep rising, as they are now, Venezuela’s example shows us that price fixing will only makes matters exponentially worse. By setting the record straight on the effects of such dangerous policies, I hope that we can disregard these imprudent recommendations and focus on using effective tools already at our disposal, like increasing interest rates.

Keep up with the conversation! Subscribe to Public Discourse today.

Subscribe to Public Discourse!