In the aftermath of the pandemic, as the global economy rebounded it was accompanied by a dramatic rise in inflation, reaching levels not seen since the 1970s, peaking at nine and 11 per cent in Europe and 11 per cent in the US. Post pandemic supply bottlenecks were exacerbated by an energy shock following Russia's invasion of Ukraine. While these were clearly the initial trigger of high inflation, a recent debate highlights an often-overlooked amplifying factor: corporate profits.

In this paper we summarise some key aspects of the literature around this, present novel firm-level analysis across countries, and highlight gaps in the research and policy debate.

We argue that market power by some corporations and in some sectors — including temporary market power emerging in the aftermath of the pandemic — amplified inflation. It made price increases peak higher and remain more persistent than they would have been in a world with less market power. To be clear: corporate profits were thus not the sole driver of inflation, nor are dominant corporations to blame for the energy shock caused by Russia’s invasion of Ukraine. But we argue that their market power exacerbated the fallout — and that this is not sufficiently captured in the prevailing macroeconomic debate or in workhorse models. We also highlight that, unlike what seems to be commonly claimed, profit margins do not have to rise in order for profits to contribute to inflation. In an energy shock scenario, if costs were equally shared between wage earners and company owners one would expect the rate of return to fall as firms do not increase prices fully to make up for higher costs, and wage earners do not fully keep up with inflation. But this is not what happened. A stable rate of return — for example, as seen in the UK — suggests pricing power by firms, which allowed them to increase prices to protect their margins.

Market power wielded by dominant firms, so the nascent literature shows, make supply chains less robust, cause price signals fail, and lead to macroeconomic tools being less effective at fighting inflation than they would otherwise be as. (Eeckhout 2022; IMF 2021). We stress that more needs to be done to tackle market power and its large economic costs. With regards to analysis, we highlight the need for a global market power index, supported by more harmonised measures of excess profits across countries. The economics discipline and macroeconomic organisations, such as central banks, need to catch up by understanding better the evolution and drivers of "excess profits" and their potential role in amplifying inflation and other macroeconomic phenomena. As the Bank of England’s Jonathan Haskell (2023) says, we need a “behavioural model of wages, prices and their interaction with monetary policy”. This needs to include dynamic consideration of how some firms protecting their profit margins can amplify external inflation shocks (Weber and Wasner 2023).

With regards to policy, we propose two major shifts. Firstly, as we argued in Hayes and Jung (2022), there is a need for a global approach towards taxing excess profits. The Economist magazine estimates these to be at $4 trillion (Economist 2023). According to an IMF working paper (Hebous et al 2022), the potential revenue from taxing excess profits globally could be $100 billion, a 4 per cent increase of global tax revenue. At the same time, if combined with pro-investment tax reform, it could increase economic efficiency by reducing inefficient "rent-seeking" by dominant corporations and encouraging productive investment.

Secondly, we argue in favour of a new direction for competition policy, which builds on the new paradigm that is emerging in the development of digital markets. Traditional competition policy is generally ex post and case-specific. More novel approaches to competition — such as embedded in the EU Digital Markets Act (DMA) and as proposed in the UK’s digital markets, competition and consumer (DMCC) bill — on the other hand, is ex ante and sector-specific, meaning it tries to set the rules of the game before any anticompetitive behaviour happens. Moreover, we see scope to understand competition policy as an instrument for facilitating macroeconomic stabilisation in a turbulent environment, and not merely for preventing and remedying microeconomic harms.

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