Bank for International Settlements paper sees significant contribution from businesses' price setting to inflation

Cast your mind back to 2023 and you may recall a debate on the extent to which businesses increasing prices had contributed to the big surge in global inflation coming out of the Covid-19 pandemic.

A key proponent of what she describes as "sellers' inflation," was Isabella Weber, Assistant Professor of Economics at the University of Massachusetts Amherst. Weber argued sellers' inflation happens when the corporate sector manages to pass on a major cost shock to consumers by increasing prices to protect or enhance its profit margins. 

Not everyone agreed. Here in New Zealand lobby group Business NZ commissioned a report from consultants Sense Partners arguing there was no evidence of widespread increases in profit margins driving up inflation in NZ.

Now a Bank for International Settlements (BIS) working paper, using barcode-level price data from 16 countries between 2005–2022, says in so-called advanced economies, "idiosyncratic firm components explain a substantial share - 41% - of inflation variance."

The paper, by Santiago Alvarez-Blaser, Raphael Auer, Sarah M. Lein and Andrei A. Levchenko, is called The granular origins of inflation.

"We decompose inflation into the component due to macroeconomic shocks and the granular residuals capturing the impact of individual firms and product categories, respectively. In advanced economies, the firm granular residual accounts for 41% of the variance of overall inflation, while the product category granular residual accounts for another 15%. Most of the variation in the firm granular residual is due to idiosyncratic shocks rather than to higher sensitivity of larger firms to common shocks. In the cross-section of countries, granular residuals are less important in economies with less concentrated market shares and higher inflation, such as emerging markets. Lastly, granular residuals contributed to the post-Covid inflation surge, with the firm-level component accounting for roughly one-third of the 2021-2022 inflation in advanced economies," the authors say.

Their analysis is based on a dataset of retail prices and expenditures from AiMark for 16 countries. They are Argentina, Austria, Belgium, Brazil, Chile, China, Germany, Hungary, Spain, France, Mexico, the Netherlands, Russia, Sweden, the United Kingdom and the United States.

Alvarez-Blaser, Auer, Lein and Levchenko's paper features a close look at the post-2020 inflation surge.

"Evidently, the post-2020 inflation was, to a significant extent, a 'granular inflation surge.' Part of the increased contribution of the firm granular component is due to a higher sensitivity of large firms to the common shocks during that period: while the differential sensitivity component ... is negligible in normal times, it accounts for over a quarter of the firm granular residual during the inflation surge. One possible reason is that larger firms, with higher import shares in intermediate inputs, were more exposed to global supply chain bottlenecks, which contributed to the inflation surge," the paper says.

"In emerging markets, the average inflation increase was much more modest in relative terms, with prices increasing by 6.69% on average in the earlier period, and by 10.56% in 2021-22."

The authors acknowledge the 2021–2022 period was exceptional given the Covid pandemic, large-scale disruptions to supply chains, and massive fiscal and monetary interventions by governments and central banks.

"Nonetheless, the experience of the inflation surge indicates that granularities can be a source of salient inflation developments. One aspect of particular relevance is the finding that the heightened sensitivity of larger firms ... amplified the underlying macro shocks."

The authors say their research shows quite a different outcome in emerging markets, where overall inflation is higher, than in advanced economies, with the firm granular component contributing only 20% to inflation, versus 41% in advanced economies.

"We also examine the role of large retailers for fluctuations in overall inflation, finding that they play a moderate yet distinct role. In the cross-section of countries, the granular residuals are more important in countries with more concentrated product markets and lower average inflation."

The Basel, Switzerland-based BIS is the central banks' bank, being owned by 63 central banks including the Reserve Bank of New Zealand (RBNZ). As of June 30 last year the RBNZ held 3,211 BIS shares, equivalent to 0.6% of all shares on issue.

Speaking on interest.co.nz's Of Interest podcast in 2023, RBNZ Governor Adrian Orr said profit-led inflation, or sellers' inflation, had been happening in NZ as it had overseas.

"We just used to call that inflation expectations and generalised inflation," Orr said.

"Whenever you've got high inflation people can hide price rises even though it's not something specific to their good or service. They can get away with high or variable inflation, they can start shifting relative prices around, and then that leads to more generalised inflation as input costs rise and wage costs rise and so on."

"And it's that scramble and mess that causes long-term inflation problems. And so I would say all of those things have been happening in New Zealand as they have been everywhere else," said Orr.

"This is the challenge for monetary policy, we have to lean against that desire to tuck a little price increase in behind generalised inflation hoping no one notices. Consumers have to be laser-like focused and think 'is that right, should I be shopping somewhere else?'," Orr added.

The working paper notes the views presented within it are those of the authors and not necessarily those of the BIS. Auer is from the BIS,  Alvarez-Blaser from Harvard Business School, Lein from the University of Basel, and Levchenko from the University of Michigan.

On Twitter/X Auer notes; "A clarification: we measure prices, not markups. We have no evidence to support or refute concepts like greedflation/seller’s inflation. A paper that looks at this is by @SEAlvarezBlaser [&] @albertocavallo, see here: http://santiagoalvarezblaser.com."

Weber welcomed the BIS paper.

Large firms price setting mattered for the return of inflation. That's why I have been calling it sellers' inflation. https://t.co/ySNpg4GN18

— Isabella M. Weber (@IsabellaMWeber) January 17, 2025

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