A Chicken-and-Egg Problem: Profits and Inflation after COVID-19
In 2022, the contribution of unit profits to domestic price pressures in the Euro area more than doubled relative to its historical average. This increase was uneven across industries and particularly pronounced in upstream sectors. While profits have attracted growing attention as a potential driver of inflation, the existing literature has not examined their role within a fully structural macroeconomic framework alongside a broad set of competing price pressures. In this paper, I propose a unified Bayesian VAR framework to disentangle how profits have affected inflation in the Euro area, focusing on the period after the pandemic. The results show that while demand and energy prices initially drove inflation, profits in upstream companies amplified price pressures, accounting for 12.2% of the increase in headline inflation above the 2% target. In the labor-capital distribution debate, profits contribute to price pressures about three times more than wages. Moreover, firms more than offset by a factor of seven the losses they incurred during the pandemic. Overall, the findings suggest that increasing concentration in key sectors poses a material risk to price stability and warrants close monitoring.