Doing his best Captain Renault impersonation, President Biden is trying to alleviate the troubling inflationary environment by “rounding up the usual suspects”. In this case, that means blame a problem that can only be caused by errant government policies on politically convenient targets such as rising drug prices, Russia’s invasion of the Ukraine, and excessive corporate greed.
The President’s assertions that these factors are driving the economy-wide inflation are simply wrong. Take the claim that rising drug prices are causing inflation.
The latest data from Drug Channels shows that drug prices inclusive of all discounts and rebates have “declined for the past five years”, not increased. Prices exclusive of discounts, what is referred to as list prices, have grown but their growth has been decelerating over time. Back in 2017, the annual growth in average list prices was 6.6%. The rate of growth fell steadily to a rate of 2.9% in 2020, before increasing slightly to 3.4% in 2021.
The declining price environment for drugs is also reflected in the latest Consumer Price Index (CPI) data. Throughout 2021, while economy-wide inflationary pressures were accelerating, the prices for prescription drugs were declining (see the Figure below) – consistent with the net price data from Drug Channels.
So far in 2022, as inflationary pressures have reached 40-year highs, the price increases for prescription drugs are growing at one-fourth the rate of overall consumer inflation. Clearly, prices that are either declining or growing less than average are not driving overall consumer inflation.
The CPI data presented above also demonstrate why the war in Ukraine is not a causal factor driving U.S. inflation. By the time Russia invaded the Ukraine in late February 2022 CPI inflation was growing 7.9% year-over-year. In January 2022, the month prior to the invasion and prior to any impacts on supply chains from the war, CPI inflation grew 7.5%. In fact, inflationary pressures were clearly building starting in the second quarter of 2021 – nearly 10 months prior to the Russian invasion.
Then there is the evergreen argument that corporate greed is driving inflation. This argument is both inconsistent with the latest economic data and logically flawed. As the figure above demonstrates, the problem of inflation started accelerating in the second quarter of 2021. And it is correct that corporate profits grew from 10.3% of GDP in the second quarter of 2021 to 10.9% of GDP in the third quarter. But corporate profits have been falling ever since.
As of the first quarter of 2022, corporate profits have fallen to 9.9% of GDP. The declining corporate profitability is also reflected in the steep declines in all three major stock indices, which are now officially in bear market territory as of late June 2022. If corporate greed were driving inflation, then profits should be growing faster than GDP not slower, and the stock market should be rising.
The corporate greed argument makes no logical sense either. Greed and generosity are part of the human condition. They are always present and not helpful for understanding the important contributions made by businesses. As Milton Friedman noted in his famous 1970 New York Times essay,
“there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”
With respect to the problem of inflation, if greed causes it, then why didn’t greedy businesspeople create inflation earlier? Why was inflation so low for so long? The answers are as clear as the decline in corporate profitability – corporate greed is not driving inflation.
Dispelling inflation myths such as these is imperative.
The current surge in inflation is the inevitable result of the policy choices made in Washington D.C. In this case, the federal government gave consumers billions of dollars of increased spending power and financed this unprecedented surge in government spending with increased federal debt. The Federal Reserve essentially purchased a large majority of the newly issued bonds, which effectively monetized it. This monetization of the debt is a core reason why inflation is now out of control.
The inflation problem was then worsened by a growing regulatory burden that has constrained oil and natural gas development in the U.S. and, more broadly, dampened the incentive to expand the supply-side of the economy. Supply constraints from the pandemic are also reducing the economy’s productive capacity.
Getting inflation back under control requires policies that directly alleviate these problems. The Federal Reserve needs to remove the monetary excesses it enabled, and it is currently implementing this policy. The federal government can help by removing the growing regulatory constraints that are creating unnecessary barriers to production. Unfortunately, its scapegoating explanations calls for the exact opposite – policies that further disincentivize the economy’s supply-side.
An effective response to rising inflation requires a clear-eyed understanding of its origins. By focusing on convenient scapegoats rather than the causal policies creating the problem, the Biden Administration is making it more difficult to bring inflation under control. The longer inflation is allowed to persist, the worse the economic consequences and the more difficult eliminating the problem will be. As with most issues, rounding up the usual suspects may be politically satisfying, but it is economically destructive.