As long as accuracy remains the number one issue that concerns citizens, the debate about “greedflation” and the extent to which it fuels the price rally will continue. Those who argue that the appreciations are largely due to the thirst of large business groups for superprofits are not heretics, but “orthodox” economists of the International Monetary Fund and the European Central Bank.
IMF research has found that 45% of inflation in the Eurozone, during the period of the great inflationary wave of 2022-23, is due to higher business profits, compared to 40% to import prices and only 25% to rising wages.
New research on inflation
While the theory of greedflation is being challenged, new research by economists highlights the role that large companies play in price formation and inflationary pressures. The research is presented at CEPR (Centre for Economic Policy Research), a European institute for economic policy, and is based on a study by the Bank of International Settlements (BIS) (“The granular origins of inflation“).
As it shows, with detailed data from 16 countries, a handful of large companies and a list of key product categories are responsible for up to 56% of inflation fluctuations in developed economies.
This has serious consequences for monetary policy, delaying the diffusion of its effects. Economists explain to us why successive interest rate increases by Central Banks were not enough to curb inflation, at least initially.
Market Concentration and Inflation
The research was based on a huge database: 2.9 billion product-level transactions (barcodes) from 16 developed and emerging economies, covering the period 2005-2020. Each product was linked to the company that produces it, the category it belongs to, and the retail chain that distributes it.
The economists found the following:
- Markets are highly concentrated: In developed countries, the 10 largest companies control an average of 41% of sales, while the top 10 product categories account for 48% of the market. This means that a few companies have enormous influence on the economy.
- Large companies synchronize their prices: There is a high degree of coordination in price changes between different products sold by the same company, as well as between products in the same category.
- Decisions of large companies have a disproportionate impact: This is the most striking finding of the study. The researchers found that the pricing policies of large companies account for 41% of inflation variation. The lion’s share is accounted for by the ten largest companies (26%), while the remaining 15% is accounted for by other large companies outside the top 10. Another 15% of inflation variation is attributed to price changes at the product category level.
- Overall, 56% of inflation variation in developed countries is due to the decisions of specific large companies and product categories, rather than general economic factors.
- Interestingly, in emerging markets, where inflation is generally higher and markets are less concentrated, large companies explain only 20% of inflation variation.
The Great Inflation Wave of 2021-22
During the great price increase after the COVID-19 pandemic, large companies played an even more important role. About a third of the inflation in 2021-2022 in advanced economies was due to the pricing decisions of these companies.
This happened for two reasons: First, because of the strategy of each individual company (e.g. decisions on profit margins). Second, because large companies reacted more strongly to common problems, such as supply chain disruptions and rising energy prices.
The example of Germany clearly shows that during the inflation wave, the effects of specific large companies played a much larger role than general macroeconomic factors.
Monetary policy
This discovery has important implications for the effectiveness of central banks. When central banks raise interest rates to reduce inflation, their policy works more slowly when markets are concentrated.
Research on the United States and the eurozone shows a paradox: after an interest rate hike, inflation initially rises rather than falls—what economists call “the price puzzle.” The initial rise in inflation is almost entirely due to large companies, which continue to raise prices.
In contrast, macroeconomic inflation (the unweighted average price) reacts as theory predicts: it gradually falls.
Large companies can delay the process of reducing inflation by passing on their financing and input costs to consumers more than smaller firms.
The economists’ conclusion
Contrary to traditional theory, inflation is not determined solely by general macroeconomic factors. The decisions of a few large companies matter enormously – and this should be taken into account by economic policymakers. Monitoring the prices set by large companies can help to better predict and manage inflation.
They wash their hands of greedflation
The political “juice” of the research is found in the asterisk in a footnote. The researchers, who work for large central bank organizations (Eurosystem, Bank for International Settlements), avoid taking a position on greed inflation.
They clarify that they do not examine the role that profit margin adjustments play in price changes. “Our findings are not directly relevant to the recent debate about whether large firms disproportionately increased their profit margins during the 2021-22 inflation surge, i.e. the ‘greed inflation’ debate.” However, they distance themselves from the greedflation theory, noting that “the available empirical evidence suggests that the adjustment of profit margins was not a significant factor in the increase in inflation.”
