Bank of Canada deputy governor Nicolas Vincent says companies that raise their prices more frequently than before the pandemic are contributing to higher-than-expected inflation.
Vincent made the comments Tuesday in his first speech as non-executive external lieutenant governor, a newly created position, to the Metropolitan Montreal Chamber of Commerce.
In prepared remarks for his speech, which was delivered primarily in French, Vincent said price increases have been larger than normal and more frequent than before the pandemic, a trend that has persisted.
“We believe this behavior by businesses – both here and abroad – is closely related to the stronger-than-expected inflation we have seen,” Vincent said.
The annual inflation rate fell to 2.8 percent in June but recovered to four percent in August, as economists expect there is a long way to go to reach the central bank’s target of two percent.
In normal times, Vincent noted that raising prices too frequently can be costly for businesses and “can antagonize customers.”
But rising costs and robust demand may be changing companies’ calculus, he said, making it easier to raise prices in a volatile economic environment.
“Under these conditions, we can expect companies to make larger and more frequent price adjustments,” Vincent said.
“This could be part of the reason why the models used by central banks have not fully captured the recent effects of supply-demand imbalances on inflation. The most commonly used models were not built to capture a change in the behavior of a company”.
Although companies’ price behavior has approached normality since the beginning of the year, the lieutenant governor said progress has been slow.
Corporate profits are blamed
Corporate earnings have drawn a lot of attention after the pandemic, as some people have questioned the fairness of rising profits during a period of high inflation.
Recent research from the central bank shows that price increases have closely reflected the cost increases that companies have faced. However, Vincent points out that even stable profit margins would mean that customers would bear the entire burden of higher prices.
The lieutenant governor says these recent discoveries about the effect price behavior may be having on inflation are leading the Bank of Canada to rethink its assumptions about what drives inflation.
“The impact of our recent findings should not be underestimated. They force us to revisit some of the assumptions we make in our economic models, as well as question the relationship between inflation and its drivers,” he said.
Vincent outlined some risks to the inflation outlook associated with abnormal corporate pricing. The lieutenant governor said higher labor and financial costs could continue to drive up prices. He also noted that the unusual price behavior could be “sticky.”
“Companies could continue to make larger and more frequent price changes even when many of the factors driving those changes have disappeared,” he said.
This could be because new technology, namely electronic price tags, makes it easier to raise prices, and consolidation in some industries may be reducing competitive pressures that make it difficult to raise prices, the lieutenant governor said.
“Perhaps the biggest risk of all is the idea that recent price behavior could be self-perpetuating,” Vincent told the business audience. “If you continue to expect your suppliers and competitors to make frequent price changes, you may be more likely to do the same yourself, creating a feedback loop.”