Chris Conlon on the Post-COVID Inflation Surge and the Greedflation Narrative

Although recent inflationary trends have coincided with periods of record corporate profits, we should pump the brakes when considering greedflation theories.

Chris Conlon is an associate professor of economics at the NYU Stern School of Business where he focuses on industrial organization economics and econometrics. Chris joins David on Macro Musings to help shed light on the 2021-2023 inflation surge from the perspective of an IO economist. Specifically, David and Chris discuss the great markup debate within IO economics, the shaky foundation of greedflation, the cost anticipation story of higher prices, and more.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Chris, welcome to the show.

Chris Conlon: Thanks for having me, David.

Beckworth: Well, it's great to get you on. I've been wanting to chat with you because your work, your AEA Proceedings, has received a lot of attention as you know, in this moment of inflation surge, inflation conversations and particularly in the context of what's been called greedflation or sellers' inflation. Your work has received a lot of attention. In fact, I heard you recently on NPR Planet Money. I know you've done a lot of interviews. We've had a lot of macroeconomists on this show, and we view things from 30,000 feet. We have these theories that we really can't truly test, so we theorize, we apply a little bit of reduced form data, but you're an IO economist, you're in the weeds, you get into the data, you actually can tell us what's happening, and again, shed some light on what you see as the story behind the inflation surge from your perspective. Chris, before we do that and get into that though, this is the first time I think I've had an IO economist on this show. So maybe tell us about your journey into IO economics and what is IO economics for all the macroeconomists out there?

Breaking Down IO Economics

Conlon: That's a good question. What we do in industrial organization is we think about how firms compete and how they set prices. Today, sort of modern IO means we think about the strategic interactions of firms in imperfectly competitive markets. As you may be aware, most markets are not perfectly competitive. In the real world, firms earn profits and make money, and we try to understand how they do that at a very sort of micro level. A typical IO study might look at a single industry… and I take a lot of heat from my macro colleagues. They're always joking, "You guys are always studying yogurt or laundry detergent or breakfast cereals, or something. I'm studying the entire economy." But what we're trying to do is we're trying to understand, look, in a market like breakfast cereals, there are four major players, and they produce lots and lots of different products, and they follow complicated pricing strategies with temporary sales and discounts and things like that. Our goal is to understand how these firms interact strategically.

Conlon: If you go back to the '80s and '90s, IO was one of the first fields to really have a game theory revolution where ... I mean, there were the very old models, Cournot and Bertrand and things like that from the 19th century. But game theory really took hold in the '80s and '90s, and now what most of the field is, is empirical IO. We've taken those game theory models, and we've tried to marry them up with modern econometric tools, sometimes pretty complicated econometric tools, with the idea that we could take these game theory models directly to the data. So that's what we do. What that means is that means trying to understand and estimate the primitives of consumer decision making, things like how you substitute across Coke and Pepsi when I raise the price of one versus the other, or how big a coupon can I get to induce you to switch from one brand to another? Then once you switch, how sticky are you? Do you go back to Coke when it's at a higher price next week or not, and things like that. We really try to understand very micro level consumer demand so that we can then think about the problem from the perspective of firms and how firms strategically interact.

Beckworth: So it sounds like a lot of elasticity estimation going on in the field these days.

Conlon: Oh, yeah. I think for a long time people have been arguing about what are the right cross elasticities for Heinz and Hunt's Ketchup or Coke and Pepsi. So yeah, a lot of what we do is trying to use as much data as possible, micro level weekly data from supermarkets or purchase data from automobiles and combining that up with consumer surveys and trying to figure out how people of different incomes respond to prices differently or in different parts of the country and things like that. So yeah, that's I think the modern IO toolkit.

Beckworth: So it sounds like modern IO is like many other applied micro fields where you're doing a lot of work empirically given the computational power we have and the big data we have now.

Conlon: Yeah, I think that's certainly right. I think we're probably… I think relative to other applied micro fields, I think the methods and the econometrics tend to be a little more complicated. A lot of the things… strategic interactions are hard to think about as just a plain linear response or linear regression. We have a lot of heterogeneity in these models, and we don't always get to see exactly what everyone does, but we see how distributions of income change from city to city or store to store. We have to try to infer what's going on at the individual level. But yeah, it's a lot of work with very big data in the last five or 10 years, especially. It was the case, computation was certainly the binding constraint even when I was in graduate school, and now that's been relaxed quite a bit, and so we have much better access to data. We have much better computer ... My phone is a better computer than my fanciest computer when I was a graduate student 15 years ago, and so we can certainly do a lot more.

Conlon: Actually, IO economists, when I think about what my PhD students do, IO economists, I think one of the big employers is not just academic jobs, but it's been a big shift towards industry because obviously we're good at figuring out what are the elasticities of things. That's one of the core things we study as a field, and it's one of the things we think we’ve solved reasonably well. Of course that's helpful to learn what firms are doing, but obviously if you're an airline or Airbnb or Uber or Amazon, you also need hundreds of people to figure out what elasticities are and how consumers are going to substitute and things like that. We have sort of been producing students with the right blend of computational and econometric training that a lot of them are getting scooped up by these firms who are trying to set prices.

Beckworth: That's interesting. You often think about which fields in business have the highest opportunity cost to be in the academy. So like a finance PhD, they can make a lot of money on Wall Street, but it sounds like IO economists, too, have a pretty high opportunity cost.

Conlon: Yeah. I'm not going to get into specifics.

Beckworth: No, no.

Conlon: But I've seen job offers from recent PhD students and yes, they are quite generous, more than I make as a professor for sure.

Beckworth: Okay. Well, we appreciate you taking time out to be with us humble macroeconomists and share your insights on inflation. But one last question from your field. So are you a Stata guy or an R guy? What do you see being used in IO?

Conlon: That's a good question. I think most of IO, if we went back like 10 years ago or so, most of IO was in MATLAB. I think it's moved in part to R and in ... I do most of my work today in Python. That's a little bit the NYU Tom Sargent effect. He's been a big, big proponent of Python. I see people using mostly Python and Julia and a bit of R. But yeah, we're doing heavy duty computation, big cluster of computers, as many processors as you'll give me. In some sense we're similar to macro in that. I think one thing that makes us different maybe from some of the rest of applied micro is that we take dynamics pretty seriously, often. When you think about many firms and many periods and many products competing over time, it's hard to think about how firms enter and exit markets without writing down something that's dynamic. People do write static entry games, but it's a little hard to even know what that means.

Beckworth: That's interesting. You mentioned before the show that your office is near Tom Sargent's office. Is that right? So you have that flavor in the hallway of macroeconomics, IO dynamism at work.

Conlon: Yeah. I'm in a sort of an unusual department at NYU Stern in the economics department here in that we're a very small department at a business school, and we kind of have just a particular style of macroeconomist who teaches macro to undergrads and MBAs. And then most of the micro we teach to the undergrads and the MBAs is taught by IO economists because we're a business school, and we are the people who study firms and that stuff. I should mention, I have two colleagues I would call sort of economic history, and I don't want to leave them out. But the bulk of the hallway is, yeah, IO and macro here.

Beckworth: Sounds like a lot of fun. I recently had on George Hall who's done some work with Tom Sargent on the history of debt. It always amazes me that Tom Sargent is still going, still very sharp. I mean, very clear. That's my hope that when I get to his age, I can also continue to produce, have clear thinking and be an interesting person. Okay, Chris, let's get to the question at hand, and this is the question of greedflation or sellers' inflation. People on Twitter know how I feel about this. I'm going to try to be very even-handed here as we go into this. Let me begin by first kind of laying the ground or the context for this conversation by just recapping what's happened to inflation, some of the views that have begun to emerge, and then we'll get into your research and then how it plays into this whole inflation question at hand right now.

Beckworth: If we go back to March 2021, things were looking fine. I mean, inflation was still low. We're coming out of the worst part of the pandemic. But starting in that month, we begin to see a pickup in inflation. This surge takes off, and no one really saw it coming. I didn't see it coming, the Fed didn't, most professional forecasters didn't see it coming. It comes in nonetheless, and, in fact, when it starts to emerge, there's this talk about, “it's transitory, it's going to pass through,” which, in part, it should have, and I think much of it has, but it was the part due to supply shocks we'll talk about, that was what we were thinking I think at the time. But this continues to go on and on, and it peaks in June of 2022. So about a year and a few months later it peaks, and headline CPI reaches 9%, core CPI reaches 5.9%, so that's June of last year, so about a year ago.

Beckworth: Now, since then, CPI has declined, headline is around 4%, so that's a pretty dramatic drop. It's a lot of success if you want to look at it from that perspective. But core CPI is down to 5.3. So core CPI has kind of gone down a little bit, moved sideways, and there's a lot of concern there that services, wages, they haven't really budged. What has the Fed done? Well, the Fed has raised rates quite a bit, 500 basis points, likely to do some more going forward. We think we see its effect on housing, but services seem pretty stubborn in terms of the inflation there. I think the Fed is waiting and also eager to really push core inflation down.

Beckworth: We look at core because we think it's where the trend is, the underlying amount. So we've made some progress in the headline perspective, but this underlying core is still an issue. The other context I would add to that is that inflation also became a very politically poignant issue too. Last year, midterm elections, it was supposed to be a red wave. It wasn't quite the red wave everyone expected, but inflation got really important. It was top in the polls. I checked, Chris, right before we got on, where we are today. So the Pew Research poll was taken early in June, still showed inflation as number one at 65%, but it's pretty close to the next. The next ones are like 64, 63, so it's still important. It's come down some. There's another poll that I follow, it's called the Ipsos Global Poll, and they look at top worries around the world. It has inflation at 41%. The next one is poverty and social inequality at 30, crime at 29, unemployment at 27. So it's still a top concern, but it's come down.

Beckworth: Then finally I had to check Google Trends. If you check Google Trends and type in inflation, you can see it really is coming down, kind of matching the headline inflation. I should add probably a lot of that headline inflation is due to things outside of the Fed's control, oil, food prices. So we're seeing progress on the inflation front, which is great from the consumer's perspective, but the underlying part that the Fed should be managing, it's having a hard time doing that. That's kind of the context of this inflation surge. I call it the inflation surge of 2021 through 2023. Hopefully I won't have to add '24 to that at some point. Hopefully we'll get down fairly quickly.

Beckworth: Let me add one last point, and that is kind of what I view as the standard story. Then I'm going to add this alternative heterodox story. But the standard story that's emerging, at least the one that I see, and I think it's pretty standard or mainstream, is that early on this inflation surge was a result of supply disruptions from the pandemic, the Russia-Ukraine War, we shut down factories, shipping lanes, global supply chains, large decline in labor force participation. So all of these things affected costs, and we'll talk about markups and prices in a minute, and that drove maybe the early part, but now we're seeing the consequences of this huge stimulus in 2021.

Beckworth: Now, let me step back and lay my cards on the table here. I think what we did in 2020 was appropriate given we forcibly shut down the economy, large injections of federal support. 2021, in my view, looking back, is definitely much more questionable. We added 1.9 trillion on the ARP under President Biden. The CBO, they estimated on the whole of about 400 billion. So it looks like in hindsight we added way too much. The Fed also kept rates low through early 2022, kept buying securities through 2022. So policy has been very stimulative. I think what we're seeing now, this stickiness, this persistence, people are attributing to demand. So start with supply, now we're switching to a demand story for inflation. I think that's kind of the standard narrative we've seen. But there's an alternative story out there called greedflation, and maybe a nicer way to say it is sellers' inflation. I want to turn this over to you now. Tell us how you got caught up in this, because you're now a key player in this whole greedflation debate. How did you wind up in the middle of it?

The Great Markup Debate in IO

Conlon: Yeah. That's an excellent question. I'm not entirely sure. The way we got started is ... Some of the work you're talking about is this very short AEA Papers and Proceedings paper that just came out in May called, sort of, *Rising Markups, Rising Prices.* And, you've probably been to the AEA conference, and if your listeners all haven't, every January there's a huge conference where 10,000 or more economists show up in some city in the worst week for the hotel industry because nobody goes away the second week of January, and there's a big conference that happens where a lot of people are trying to find jobs and fresh PhDs are all trying to find jobs and things. But in the background there's papers being presented and stuff like that. In June, usually the year before, the different fields within economics have their own respective society, so the IO Society asked my co-author, Nathan Miller, at Georgetown, to write something about markups, in part because he had done some work on markups in the cement industry and then he had done some other work that maybe we'll talk about a little later, on markups in consumer products over a longer time horizon. They asked us to write one of these five-page papers. We were trying to figure out what we could do in five pages that wouldn't cannibalize both of our other research but that also would be interesting.

Conlon: The big debate in IO, even before the inflation stuff kicked off, was this paper that was IO and macro intersection, was this paper by De Loecker, Eeckhout, and Unger on rising markups. What you can think about that paper as doing is thinking about a firm as trying to minimize their costs to produce a particular level of output and then backing out from those first order conditions from cost minimization, they're trying to recover what we might normally do to recover a production function, econometrically. What they said is they said, look, actually there was sort of a previous literature in part by De Loecker and Warzynski, or even back to Bob Hall, that says, actually given some additional assumptions, you could try to turn revenues from the firm level and then variable input expenditures, so your cost of goods sold like we would see in accounting data, and to try to turn those and some output elasticity into an estimate of the firm level markup of price over marginal cost. So that was sort of this big paper that came out in the QJE in 2019, but people had seen it for years before. This was sort of a big fact because the finding in that paper was that since about 1980, markups were maybe 1.2 times marginal costs, so 20% above costs. If you looked more recently by 2017, 2018, they were 1.6 times marginal costs.

Conlon: There's a huge debate going on in IO as to, well, A, is this true in modulo, some measurement issues. I think certainly revenues over cost of goods, I think we know for sure has gone up. But then the question is, well, what's causing it? What's driving these things? I think in some sense, the perspective of IO economists is always that markups or market concentration, like how many firms are in an industry and how big they are, markups, how profitable are the firms that we see, we think about those things as outcomes of a game played by firms. And we think about the causes and inputs as things like demand and supply and the nature of the game and the strategic interactions between the firms. Are we competing or are we colluding, what I might call, conduct, and then beliefs about the future.

Conlon: There's a lot of debate in the IO literature, but I think also all through economics, about what's causing the rise in markups. We had this very simple idea at the time, which was, "Well, let's just look at the firms at a firm level, whose markups changed from 1980 to 2018, and were those the same industries where the BLS, through the producer price index…" because those are the prices of US producers, because we can only get accounting data on US listed publicly traded firms, “and, were those the same firms that saw the industry prices go up?” So, were markups rising in the places where prices were rising or not? And you might say, "Well, there's almost an identity, which is if price over marginal cost is going up, you would think prices were going up where costs were going down." So marginal costs are basically impossible to measure effectively because we don't know the opportunity costs of firms, what they could be doing instead and all of this other stuff.

Conlon: Prices are not terribly hard to estimate, although, it's always hard to figure out what is the markup of General Electric. It’s sort of a crazy question, the markup on MRIs or jet engines or financial services or light bulbs or which product? But if you look at those two things, if you look at the change in markups at the firm level and the change in prices at the industries in which we think those firms operate ... These are official NAICS code classifications for what industries these firms are supposed to be operating in ... We found that the correlation between those two things from 1980 to 2018 was basically zero. Then we said, "Okay, well, great, we've replicated the old paper and we've looked at, do prices seem to go up in industries where markups are rising?"

Conlon: Then we said, "Okay, well it seems like all of a sudden, it's 2021, 2022, people are interested in inflation, why don't we look and try to extend this to what's happening today. Surely we're going to find some correlation there." You would think, oh, automobiles, auto prices were really high in 2022, firms were reporting high profits. Surely we're going to see sort of a correlation. Even there at the firm level, the correlation is almost zero. Even if you go two-digit industry by two-digit industry, so manufacturing versus mining or energy extraction or things like that, the correlation is still almost zero. On one hand, maybe we've just completely mismeasured everything. We presented this in January at the AEA meetings. It was sort of a Rorschach test because it was this scatter plot of points with no correlation whatsoever, and then everybody saw what they wanted to see. Some people were saying, "Well, we're just not measuring markups correctly from the accounting data." There are people who didn't like De Loecker, Eeckhout and Unger who were like, "Well, this is just a sign they haven't measured the markup correctly."

Conlon: Then there were people who are like, "Well, the industry classification system we've known is just not the definition of a relevant competitive market. So you can't just use two-digit industry or six-digit industry. Those aren't going to give us the relevant prices for the firms." Then there were people who have said, "No, no, no. This is all costs. Everything we're seeing in the data is that, yeah, the prices are moving around and the markups are moving around, but what's really moving around both of these things are huge over the long time horizon are huge changes in scale.” That if you look at a particular industry, you could look at something like wholesaling. Wholesaling, we've seen prices come way down, but we've seen markups go way up.

Conlon: This is work by Sharat Ganapati, also at Georgetown. Why does that happen? Well, we get IT, and the efficient scale of running a wholesale distribution center goes way up. So you just want to run these massive distribution centers because you have IT. So what are you doing? You're taking some fixed costs, and you're investing a ton of money in fixed costs, and you're doing that to reduce your marginal cost. So price relative to marginal cost goes way up, but actually your savings on the marginal cost are so strong that actually prices come down. That's one of the goods stories. There are other stories, like, Why do we see this? Well, in this work with Nathan Miller and Yi Yao and Tsolmon Otgon all at Georgetown ... Nathan is a professor there. The other two are graduate students in the economics department at Georgetown who we worked on this paper with. But Nathan Miller has another paper, kind of a little bit before, that looks at what's happening to markups in a variety of consumer goods. He has a paper with a set of co-authors. There's also sort of a competing paper, a guy named James Brand who was on the job market a few years ago. His paper, they wrote very similar papers and with very similar findings. That is, if you go and look at consumer products sold at supermarkets, one fact we see at the micro level is that demand appears to be getting less elastic over time. And from an IO perspective, we would say probably that means markups are rising.

Conlon: As you face a less elastic demand curve, your price cost margin should rise holding all else equal. You could ask, "Well, why is that? Why have consumers become less price responsive?" I would say, "Well, that's another puzzle that we still don't have a solution for." I think some people have said, part of this is like we're getting richer and these products are not that expensive, and in part, maybe a lot of this is cost savings that are not being shared with you and me. So that the prices are kind of fixed in nominal terms, and we've just gotten way better at producing tee-shirts and ketchup and-

Beckworth: So quality has gone up.

Conlon: Laundry detergent. Yeah, and so maybe it's the quality has gone up. I think certainly what we know we can see in the data is that variety has gone up, particularly for the kinds of varieties that rich consumers prefer. So 20 years ago, there was no Greek yogurt in the supermarket. It turns out people who earn over $100,000 really like Greek yogurt relative to the older yogurts that we had when I was a kid, and they pay more for them. That's a welfare goes up story. Not every story is probably a welfare goes up story. In IO, we have a list of markets that we know are just competition disasters, and it's why people write paper after paper about airlines and energy producers and lots of these beer distributors. I've written papers on liquor distributors, and these are markets where there's not a lot of competition, there's a small number of players, often they're engaged in repeated interactions where they're probably kind of cooperating to charge us high prices. So a lot of IO, we were concerned with usually the markets that don't work well at all. But I think it was surprising that we sort of have these different pieces of evidence. One is that it seems like markups are rising from 1980. One is that it seems like at least in some segment of consumer products, things you could buy at a supermarket, consumers are becoming less elastic. But then for a long time, from 1980 to 2018, the one place we didn't see markups rising so much was in the price index.

Conlon: Markups went from 20% to 60%, but we didn't see it so much in prices, at least not on most of the things that you and I would buy. So that either implied huge productivity gains that somehow aren't showing up in the productivity data or some other stuff. That's what people in IO have been trying to puzzle over and figure out. Macro folks have offered some of their own explanations that superstar firms, if you drop Amazon and Google, and so these firms that have markups that are almost infinite, their costs are so low relative to the revenue that they bring in, are these things just skewing the average? Or is it that globalization has meant all the low markup firms just exited the US market in the '80s and '90s, and we don't make crappy low margin tee-shirts anymore? They make them somewhere else? So the average markup is going to rise purely based on selection. There's a lot of debates like that. I don't even know where I come down on this. I think, probably, markups have risen since 1980. I'm willing to believe that. But why, I think we don't have a handle on, and there's definitely a group of people who would say it's sort of been lax antitrust enforcement in the US. People have also found sort of similar rises in markups in Europe. If you think they've been really tough in Europe and really lax in the US, that makes that a tougher-

Beckworth: Bit of a puzzle

Conlon: Explanation to buy. Yeah.

Beckworth: Well, that's very fascinating and sounds like you have your work cut out for you empirically in IO. Let me go back to your paper and just again, make the link between it and this kind of greedflation story. What you highlight, what you find, is that the markup and prices aren't correlated at all. In fact, it's a very striking scatter plot. We'll probably link to your paper, but it looks like a shotgun blast. It's almost like a random distribution, and there's nothing there. Well, apparently some people at your presentation did see something there. For the casual reader like myself, you can clearly see there's nothing in the relationship. Is the implication from that to this broader debate that even if profits are going up in some firms, it's not being carried over into higher prices, and therefore the greedflation story has a shaky foundation? Is that the implication of your work?

The Shaky Foundation of “Greedflation”

Conlon: Yeah. I think it's a little hard, always, to over interpret a scatter plot with a correlation of zero as proof or disproof of anything. But yeah, what did we find? We found, if you look at ... So we originally did this looking at 1980 to 2018, but then when we looked at the current period, it also was an R-squared of the regression of 0.0002 or something. It was like the smallest R-squared I've ever got ... I've taught econometrics for 10 years, and it's hard to find real data where the R squared is that low. Rises in markups were not explaining much of the rises in prices. I mean, literally zero. So what does that mean for sort of greedflation as a theory? I mean, even we, when we ran it, we expected to find, okay, at least in manufacturing or certain kinds of manufacturing, you would expect to see prices were rising and also markups rising.

Conlon: Again, I don't know that that story, even if we saw that story, would be proof or disproof of sort of the greed story. It's very easy to generate, in our typical simple IO model, firm has a first order condition and they're trying to maximize profits, and if demand becomes less elastic or the demand curve shifts out, you expect to see prices go up, you expect to see outputs go up, and you expect to see profits go up. Strong demand is good for profits, and so we didn't see much correlation between price changes and rises in the estimated markups. Again, it could be we're just mismeasuring everything. It's hard to measure these things. I'm a guy who wants to try to spend a year of my life trying to estimate the right elasticities for breakfast cereals so I can tell you with great confidence what are the profit margins of cereal makers. The idea that we can do this for 3000 firms at the same degree of accuracy, I know is impossible. We can't do it to the same level that we'd like.

Conlon: But yeah, we don't see this correlation. If you think the cause of inflation is markups are rising and that's causing higher prices, I would say this maybe throws some cold water on that particular mechanism. But I think the thing that upsets me the most about the greedflation theory as it's been explained to me or as I’ve tried to understand it, is that there was something that sort of caused everybody to wake up and decide to increase markups, and that's something… we can't use the word demand to explain what causes a change in markups. What I would call that in my IO world is a change in firm conduct, that somehow we were playing a competitive game, and when we were looking at how we map demand and marginal costs and beliefs about the future, how we map those things into prices, that somehow this conduct, this sort of nature of strategic interactions or equilibrium among firms, changed, and we all decided we were going to set margins really high, sort of independent of strong demand or expected future cost increases. If that's the theory, I think that would be a challenging theory both to test, but also I think to find great evidence for, if that makes any sense.

Beckworth: Yeah, and I want to come back to that. You lay out four possibilities in your Twitter thread. We'll also provide a link to that, which is a nice summary of this debate and where you come down on it. But let me go back again to the markup. The idea behind the markup is it's maybe a measure of economic profit because you're looking at not just cost, but marginal cost and economic profit can be different than accounting profit. This may be the answer to the question I'm about to ask, but if you look at aggregate profits, look at a BEA's aggregate profit measure, it's reduced form, it definitely brings a lot of stuff together, like, how do you cook that sausage? What comes out is that you do see an increase in profits in the aggregate. How do I reconcile that with what you find in your data?

Conlon: Yeah, I mean, I think that's a good question. I don't know that we have a great answer. I mean, one story is [that] they might just not be the same firms. The firms whose markups seem to be rising since 2019, we can find examples where profits and prices went up a lot because it's a scatter plot and there's going to be some of those. But we can find cases where profits went up a lot and prices seem to have gone down or profits went down and prices went up. It's a little hard to think about what exactly would generate that.

Conlon: If you look firm by firm, it's clear you definitely did not want to be an oil producer in 2020. We were all sitting at home not using energy. They were shutting down oil rigs and closing refineries and stuff. That industry lost a lot of money in 2020. When we reopened and everybody decided to drive everywhere and get back to moving around the country, supply was really slow to recover. If you were one of the people who was producing, this was really great for your profits, so you looked super profitable. Prices were high. I think one of the puzzles there was that was a case where we kind of lost track of these oil rigs at some point when everybody was going bankrupt in 2020, and we couldn't get new rigs online, and so when you talk to people in the industry, they were saying, "Yeah, yeah, we want to buy rigs, we just don't know who's selling them. We can't seem to find any." It was like a lot of them were held by these bankrupt entities and stuff like that, but it took a while to ramp up production in the US, well, I think a lot longer than people thought. That was good for the profits of these firms. Obviously it wasn't good for you if you weren't producing. It was good for the ... It's always good when your competitors shut down-

Beckworth: It's good for the survivors.

Conlon: It's great for profits. Then later in oil, we saw the situation with Russia invading Ukraine. Obviously if you take a bunch of global supply offline, one way to describe that is a supply shock, but if you're only focused on the US market, that's again going to function like a shock to residual demand. Your demand curve gets shifted way out because this global market, we just took a bunch of supply online. What does that mean? That means quantity is going to go up, it means prices are going to go up, it means profit margins are going to go up. For those kinds of markets, I think there is a clear story. For other markets, remember, where did we see prices going up the most in 2021? It was things like used cars. This is a market where there's almost no market power. You and I and everyone else, 100 million households in America are potential sellers in the used car market. It's very hard to think there's coordinated greedy behavior in used cars, so that has to be a story of demand and supply. It'd be very hard to think there was a huge change in conduct. You can say, "Oh, Carvana got larger as a big buyer and seller in the used car market." You see people telling the same story in housing. BlackRock got bigger as a big buyer of residential real estate, but they're tiny. They don't own 10 million homes. So, when the biggest sellers are pretty small, maybe in some city somewhere the used car market is dominated by one guy, but national markets for these things, it's very hard to explain them with big changes in conduct, which is not to say we don't think conduct is a problem elsewhere.

Beckworth: So the point is the aggregate measure is it's aggregating a lot of different firms, and we can't really see what's going on underneath the hood. There's a lot of important details that we miss. So let me go to that list of yours where you try to explain what could be behind it. You've already touched on them. One, you have demand, more consumers willing to pay more; Two, higher costs, constrained supply, things that would contribute to the story; Three, and this is an important one, expectations about beliefs about future prices. So this is maybe a great time to segue to the Kansas City Fed study. Then fourth would be the coordinated behavior. That's where the greedflation story comes in.

Beckworth: Let's talk about the third one then, expectations about beliefs. So the Kansas City Fed story is often used as a reference point for those who take the greedflation view. They point to that, and I think if you actually look at it and you note this in your tweet thread, it actually says something very different than what the advocates say. I believe what they say is it's actually pretty normal for firms, if they're anticipating cost increases in the future, to get things in order, increase their markups in order to prepare for that cost shock coming down the road, and that we shouldn't be surprised, especially during a recovery. During a recovery, the economy's heating up, things are going to get more expensive, and therefore it's normal to expect something like this to happen. Is that your understanding as well?

The Kansas City Fed Story: Anticipating Cost Increases

Conlon: Yeah, I think that's both how I would understand the Kansas City Fed paper, and I think that's pretty close to ... People always ask me, do you disagree with… the Kansas City Fed found evidence that it was rising profits causing inflation. I say, "Well, did you read the paper?" Yeah, I think the fact is, for sure, we saw record high increases in profits in 2021, and then they peaked in sort of early 2022. That's I think the one of the stylized facts. But then what we also see is we see cost pressure come in 2022 in part through wages, but in part through other inputs. What the Kansas City Fed paper says is they say, "Yeah, profits went up first. But it's not an unreasonable idea to think what actually could have happened is we are facing strong demand so we have the ability to raise prices today in 2021. But also we're starting to hear workers are coming into your office and they're saying, 'Hey, I think I need a raise,' or, 'The job market is pretty tight. Not everybody's back at work yet, things are reopening. I feel like I deserve a raise.'"

Conlon: But also things like your contracts with suppliers are not renegotiated every minute of every day. That might be a six-month long-term contract or a 12-month long-term contract or something like that. So your suppliers are telling you, "Man, my costs are going up." What you're hearing is, "Well, your costs are going to go up soon." It's not too surprising to think firms might get out ahead of this. If they can raise prices faster than workers can raise wages or that other upstream firms in these sort of business-to-business contracts can raise prices, if it's just that retail or consumer-facing prices can adjust more quickly… If we think we got a big demand shock and we think supply is constrained and we think inflation is coming because of loose monetary policy or fiscal stimulus or whatever else ... I don't know, I'm not a macroeconomist, I don't know what moves expectations, but as long as we expect costs are going to rise in the future, when you're setting prices today, the right marginal cost is your opportunity cost. If you're the guy on the car lot ... I have a friend who runs a GM dealership. If you're a GM dealer and it's 2021 and GM is saying, “Hey, we got a shortage of microchips. You're not getting many trucks next month," and all of a sudden lots of buyers are showing up and offering you cash to buy cars and you're running out of cars on the lot, of course you're going to raise the price.

Conlon: You're going to say, "Well, why would I sell it at MSRP? I can charge $5,000 over MSRP, and I still have a waiting list of people and I know I'm not getting trucks next month. And GM is telling me, 'Man, costs are going up. We can't get our hands on enough microchips. We're bidding with Ford to get the last batch of microchips.'" It's not so surprising that we see consumer-facing prices go up more quickly. I don't have the perspective of a macroeconomist. I've talked to macroeconomists about this. There's always a question in these macro models, particularly these sticky price models, who gets to move first and who gets to adjust their prices? From a micro perspective, I would say adjusting retail prices for many goods is pretty easy. Business-to-business prices are often governed with longer term contracts. Sometimes they're cost plus contracts, so the pass through is kind of instantaneous; that is whatever I buy my inputs at, I just charge you 20% markup and sell them onto you.

Conlon: But a lot of contracts were negotiated in state and nominal terms. The price of a container full of bolts or microchips or something, we negotiated six months ago, and that's locked in for the rest of the year. So it's not that surprising to think that the people who can adjust their prices quickly, in strong demand, saw profits go up. But then a lot of those firms saw costs go up in 2022. I think that's consistent with what the Kansas City Fed paper says. They say, "Look, we attribute the rise in prices to a lot of profits in 2021, but then by 2022, profit margins are going down, costs are going up. So this could all just be expected changes in future costs." Again, the evidence is very aggregate.

Conlon: It's just like BEA data where there's one good for the economy and it has a price and it has a labor input and other inputs from materials and some profit share or some capital inputs or something. I think there was this study by EPI in 2021 that said half of inflation is caused by changes in profits. That was just using that same BEA data. If you redid that today ... I think there's a chart in my Twitter thread that I just update every quarter. If you redid that today and you just extend price changes and profit changes and stuff for this one unitized good that represents the entire economy, the profit share for the last three quarters is -40% because profits have been declining, but prices are going up. But if you go back to the beginning, if you go back to 2019 or 2020, profit share from 2019 to the most recent data we have today is 26%, and labor share is 55% and other materials are about 18%. And so, that's not even that far off of historical averages. And so, when you look at the totality of the whole episode, it seems like the story I think that's starting to develop is a little bit of a timing story that was consumer-facing firms were just able to move faster. You don't want to be the firm that's slow to adjust. Wait until your costs go up.

Beckworth: It's a very different motivation here. I mean, that's what comes out of this paper, at least for me, is firms are forward-looking. They're anticipating cost increases and they're responding. The causality, I guess, is different for them than maybe for someone telling the greedflation story. The greedflation story is firms are being greedy, they're coordinating, they're doing something, and that jacks up price as a result of the profits. But the Kansas City Fed has causality in the other direction. Let me go back to your first point though you made in your tweet thread, and that is demand playing an important story. That's where I will step in as a macroeconomist and say that to me seems to be very compelling. Let me just throw a few stats out to make the case for this. This is very aggregate, so I'm going to be guilty of being a macroeconomist from 30,000 feet looking down.

Beckworth: But if you look at the dollar size of the US economy, and I like to look at nominal GDP, but we can also look at just consumers too. But the dollar size of the economy is about $2 trillion larger than its pre-pandemic trend path. So if you just draw a trend, kind of what was growing, we're $2 trillion higher. That's money being spent somewhere. That money didn't just magically appear. In other words, macroeconomic policy had to support that growth in spending through fiscal policy, through monetary policy. To me that magnitude is just too big to say firms somehow cost consumers $2 trillion more. If you look at the PCE, it's about 1.8, but the same story holds. So the magnitudes are just so big that one, it's hard for me to look at the profit, greedflation story, but the other thing is it's a great story in itself in that from macroeconomics, we have this identification problem. What really is driving what? We have, in the aggregate, profits going up, we have inflation going up. Well, there's a third thing causing both of those: really strong aggregate demand. I think that's an easy story to tell. I just want to throw this out there for all of our listeners, and we're going to have Ricardo Reis coming on in the future to flesh this out a little bit more, but if you take any kind of standard macro theory, it would've predicted some surge in inflation. Again, it wouldn't have predicted the supply side stuff, but definitely some surge.

Beckworth: If you take a New Keynesian theory, which would look at the difference between real rates and expected neutral rates, we see a big surge during this period. If you take an old kind of hydraulic Keynesian view, I already mentioned the $1.9 trillion injection, CBO was a 400 billion, that kind of hydraulic Keynesianism, that would also say there's going to be a big inflation surge. Taking kind of an old monetarist view and the M2 money supply grows from 15 trillion to 21 trillion. There's a new monetarist literature, they look at total government liabilities, Treasuries, $5 trillion added through 2021. Fiscal theory of the price level, it's looking at the deteriorating primary surplus position of the government. It also would predict ... All of these theories would predict some strong demand, and as a result, probably at least the aggregate profit margin going up at least in the short run if you got any kind of sticky input prices.

Beckworth: To me, this is an easy story to explain, and it's been really puzzling to me to see so much effort put forth. I honestly think it's a bunch of online people mostly. There's some journalists as well that really have promoted this and there's some economists as well, but this to me has been more of an online phenomenon than it is I think something that's been accepted in the mainstream. Is that your sense too, that kind of mainstream economics, definitely the Fed doesn't buy into this... I know the ECB leader, Christine Lagarde, did talk about this, but I don't think they're approaching the problem from the perspective of greedy corporations jacking up inflation. What is your sense?

Is Greedflation Seeping Into the Mainstream?

Conlon: Yeah. I'm a micro guy, so the thing I will not answer is I will not tell you how much of this is monetary policy versus fiscal policy moving demand around. What I can tell you is that it looks to me in the data that I've looked at, that demand looked pretty strong in 2021. Part of that is we had generous fiscal stimulus. Part of that is we had pretty lax monetary policy. Part of that is I sat at home for a year watching Netflix in a New York City apartment, and I was like, "Man, I got to get out of here." Other people I know are like, "Yeah, I spent it at home cooking, trying to learn how to cook in this tiny kitchen." So everybody tried to buy a car and renovate a kitchen and buy a home and all of these decisions ... Eat out at restaurants all the time. In my neighborhood restaurants are packed on Tuesday nights still. There was a lot of pent-up demand to consume stuff. Now, obviously, if my stock portfolio was down, and I was worried about losing my job, I might not have so much pent-up demand to go eat out at a restaurant or buy a new durable good or something like that. But yeah, I think we know for sure demand was strong, but I can't tell you what macro phenomenon caused that. That's for the other guys down the hall.

Beckworth: Yeah, but is your sense though, talking to your colleagues, going to conferences, is your sense though that the whole greedflation story is not something kind of seeping into the mainstream profession?

Conlon: Yeah, I think that's right. I'm an IO economist, and I do a lot of work that relates to antitrust. So when you go to IO conferences, sometimes you'll have economists or officials from the Justice Department Antitrust Division or the Federal Trade Commission, or I gave a talk a couple weeks ago at the Competition and Markets Authority of the UK, I was at a conference in Europe among other economists that study how firms compete and set prices and stuff in Cambridge in the UK a couple weeks ago, and I think people are concerned in the broad sense with rising markups. Again, we are the people who think firms are colluding, and we're going to find the econometric evidence to show you these are the firms that are colluding and when they're doing it and this stuff like that. But I think the idea that there was some economy-wide switch that changed the nature of competition that got flipped in 2021, we don't have any evidence yet, and the data will come in in the next few years when we get really good micro level prices of lots of different products and things like that.

Conlon: But is this something that people are discussing as a serious theory or that something we would expect to find broad based evidence for? Probably not, but we're IO economists, so if you tell me somebody's going to come up with a paper in a year or two that says like, "Oh, these airlines started colluding on this route in 2021," I would say, "Yeah, probably. This stuff happens all the time," or generic pharmaceutical companies are colluding again in different classes of drugs. Yeah, these people get caught doing this stuff all the time. Yeah, we are prone to thinking firms are doing ... Most of my research is looking at firms that do dodgy and often illegal stuff and trying to find econometric evidence that you're getting cheated by liquor distributors, or firms are abusing vertical contracts to exclude rivals from markets. We're not the people who think markets work. We're the people who think markets are breaking all over the place all the time. And so, you go to an IO conference and do you think, "Oh, there was a big shock in the nature of competition in 2021?" I don't think that's the theory anyone's putting forth right now. It's not one that I'm seeing, and I think ... I don't want to get too much into the causes or the whys of why this greedflation story has been so successful as a narrative, but I think in some sense, the easiest explanation is that if you asked people, "Well, why do prices go up? Why do prices at the supermarket go up?" And you're like, "Well, the guy at the supermarket raised the prices," is sort of the most obvious culprit.

Beckworth: Right. It's easy.

Conlon: Yeah. You can’t walk into Walmart and raise the prices of things, but you do. You do because you go there and they raise the prices and you still buy the things. I think the most obvious explanation is if sellers aren't raising prices, who is? Or that somehow firms should only be raising prices just to pass through cost increases and not to match increased demand or something, those are theories I think we don't believe. We've known for a long time sellers raise prices even when costs don't go up, when demand is strong, or when competition is reduced, or things like that. Do I think there was a big change in competition? No. Do I think markets were competitive in 2019? Not really. But I don't know that it got so much worse that it could explain the price increases that we've seen in the last few years. I think that's kind of the big challenge for the narrative. But I think the narrative… it's intuitive, it's easy. I think there's certainly a populist element out there both on Twitter and in all of America, that people believe, left and right, greedy corporations are out to screw you and to cheat you, and they're not always wrong.

Conlon: I mean, a lot of my research is finding the ones that are, and I think that makes it sort of an appealing narrative to lots of people. What I'll also say is that I think there was certainly some political interest from some of these groups who felt like economists had too much influence in the policy sphere and to try to discredit economists more broadly. It's been a part of the agenda for some of these groups, and I think the question is why? Well, I think some of the view on this populist, maybe Left, that's sort of had this… four or five think tanks have sort of spurted up in the last five or 10 years, I think one view that they have is that loose monetary policy has been really good for workers at the bottom of the income distribution. So we don't want to have a contraction in monetary policy because it's going to be bad for the poorest workers, and we can debate whether or not that's true.

Conlon: I'm not the person to ask about how monetary policy affects income inequality. I remember when people were complaining [that] loose monetary policy inflated the assets of hedge fund people. That was not long ago either. But I think if you take that viewpoint, I think the thing that they really didn't want to do, why do we need to do price controls and these things to control inflation, is that people really didn't want to have a tightening of monetary policy. I think because the fear was it would hit the most vulnerable workers and sort of the bottom of the income distribution. It has been true in this inflationary episode. Wages at least have seemed to have increased a little bit faster at the bottom of the distribution than at the top, which is unusual. There's a question of whether or not low wage workers' wages have gone up enough to compensate them for rising costs for everyone everywhere in the US, because when you ask people, poor people are still upset about inflation quite a bit.

Conlon: But I think there was an unwillingness to say demand and to blame either stimulus or monetary policy, and we wanted to keep interest rates low, and we wanted to say stimulus checks were good. I'm not the person to ask, but if you told me back in 2020 or 2021, "Hey, we're going to run the economy hot. We're going to try to help out the people at the bottom. If inflation runs 4% for a couple of years, we've been under a few years. We screwed up by not running it hot enough after the great financial crisis," I think that would've been a story policymakers could have told. I'm not a political messaging person, but I think there was a little bit of a desire to say, "No, no, no. We can't say the word demand because if we'd said demand, it would implicate stimulus checks or monetary policy or things we think are good and [that] should keep happening. So we're going to say it's greedy firms. We need price controls, we need other ways to control inflation beyond the usual thing, which is raising interest rates."

Conlon: But I mean, I think the good news, and you probably have a better perspective than I do, the good news I think is that the Fed has been raising rates, which is not good for any of us, but the good news is that it seems like expectations about inflation are starting to cool. And so, it looks like the conventional monetary policy toolkit is working in a conventional way, at least from my outsider perspective, and so, that sort of, “this time is different, and we need to blow everything up and start with a new theory of everything,” actually, it kind of looks like a pretty typical inflationary episode. Maybe it was supply shocks that were coming from wages or demand shocks that kind of kicked it off. But I think once inflation started, to me it looks like pretty standard inflation with a pretty standard textbook story and then a pretty standard textbook response, seems like it's doing the trick. So it's hard to understand if you think it's greedy firms and you told us, "Well, monetary policy isn't going to work," I think the challenge becomes, "Well, why does it look like it's working?" But I could be embarrassed in six months-

Beckworth: No. I think you're right.

Conlon: We could be at 9% inflation, and I would look like a fool.

Beckworth: I think you're right. There were a number of people who were early on really stating big concerns about the Fed's rapid rate hikes, and yet the economy has proven resilient. And I think, if anything, the fact that the economy was so overheated, there was so much money added ... If you look at household balance sheets, they still are sitting on a lot of liquid assets. I think that has allowed the Fed to hit the brakes, slow things down without causing a recession. I think more and more that a soft landing is becoming possible. You're right, inflation expectations are well anchored, and even though core inflation hasn't come down as much as headline, I do think it's on a path to do that. I do think it just takes time for these effects to work through. So I do suspect, when this is all said and done, Chris, we're going to look back and get a good chuckle, good laugh out of this whole experience, maybe learn a few things along the way too.

Beckworth: But inflation I believe will come down, and we will see that it was a combination of supply disturbances, some excess demand that we kind of brought out of the system through policy tightening, and I think that things will all turn around and greedflation will be, again, a distant memory. I mean, I just saw today in the New York Times, they're now talking about “funflation,” which is people spending a lot of money this summer on Taylor Swift concerts or Beyonce concerts. Someone literally called it funflation, and I think funflation, too, is going to end. These are all just little things we're coming up with. I think this is all going to come to a head here and I'm hopeful. I think the Fed fell behind the curve, but now it's doing its job, and there's reasons to be hopeful. But with that, our time is up. Our guest today has been Chris Conlon. Chris, thank you so much for coming on the show.

Conlon: Thank you so much for having me, David.

Photo by Josue Decavele

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.