Did profits cause inflation?

Abstract

A popular narrative has attributed the post-COVID rise in inflation to a rise in corporate profits. The literature in industrial organization offers three reasons for price increases: greater demand, greater marginal costs, and softening of competition (conduct). I argue that only sensible interpretation of the “Profits-Inflation” hypothesis is that a change in firm conduct was the primary cause of inflation. However, I also find that most of the evidence cited in favor of the “Profits-Inflation” hypothesis, such as elevated profit margins or capital share of income, is unable to distinguish between increased demand and a change in the nature of competition.