Rising profits are driving inflation, UBS economist says

Ahead of another expected interest rate hike from the Federal Reserve, a top economist at Swiss bank UBS is warning that high inflation is more the result of rising profits than wages and that Fed Chairman Jerome Powell needs to explain exactly how he thinks higher rates are going to bring down rising prices for consumers.

“Powell’s public remarks offer little insight into how he expects higher rates to tame inflation,” UBS Global Wealth Management chief economist Paul Donovan wrote in the Financial Times on Wednesday.

“The omission matters as the current policy tightening will have an impact through an unusual route. That is because today’s price inflation is more a product of profits than wages,” Donovan added.

Corporate profits have soared during the recovery from the global shutdowns caused by the coronavirus pandemic, with private sector giants from the energy sector to the financial sector posting huge gains. JPMorgan Chase & Co. pulled in a 30 percent profit margin in the third quarter.

Many CEOs on earnings calls in a variety of different industries have indicated that inflationary expectations are allowing them to raise prices on consumers to increase their margins without scaring them away.

“Companies have passed higher costs onto customers. But they have also taken advantage of circumstances to expand profit margins. The broadening of inflation beyond commodity prices is more profit margin expansion than wage cost pressures,” Donovan wrote.

These increases have some macroeconomic tailwinds, some economists have noted. 

One recent influential study published in the Quarterly Journal of Economics found that the average profit rate since 1980 has increased from 1 percent to 8 percent and that price markups over that period increased from 21 percent to 61 percent.

Profit as a share of gross domestic product has also been rising.

“The 12.4 percent profit share we saw in the second quarter is above the 12.2 percent peak share we saw in the 00s, and far above the 10.4 percent peak share in the 1990s,” U.S. economist Dean Baker wrote in an October blog post.

“It hardly seems as though businesses are being forced by costs to push up prices. It instead looks like they are taking advantage of presumably temporary shortages to increase their profit margins,” he wrote.

Both Baker and UBS’s Donovan have also cautioned about the power of “storytelling” in driving inflation, which can discipline consumer expectations into accepting higher prices.

“Consumers seem to be buying stories that seem to justify price increase, but which really serve as a cover for profit margin expansion. Indeed, the soundbite economics of the Twitter era helps this process along,” Donovan wrote.