Bank of Canada Deputy Addresses Escalating Price Increases Aggravating Inflation

04 Oct, 2023

Bank of Canada Deputy Addresses Escalating Price Increases Aggravating Inflation

Nicolas Vincent, Deputy Governor of the Bank of Canada, has voiced concerns about the frequent price increases implemented by businesses, suggesting that this behavior is contributing to higher-than-expected inflation. In his inaugural speech as the newly appointed External Non-Executive Deputy Governor, delivered primarily in French to the Chamber of Commerce of Metropolitan Montreal, Vincent discussed how price hikes have become more pronounced and frequent compared to the pre-pandemic period, a trend that continues to persist.

Vincent noted, "We believe that this behavior by firms—both here and abroad—is intimately linked to the stronger-than-expected inflation we've seen." While the annual inflation rate dipped to 2.8 percent in June, it rebounded to four percent in August, indicating a challenging path ahead in achieving the central bank's target of two percent.

Traditionally, raising prices frequently posed risks for businesses, potentially alienating customers and incurring costs. However, Vincent pointed out that the combination of rising costs and robust demand may be altering this equation for businesses, making it more feasible to increase prices in the current volatile economic environment.

He elaborated, "Under these conditions, we may expect firms to have larger and more frequent price adjustments. This could be part of the reason why the models that central banks use haven't fully captured the recent effects of supply-demand imbalances on inflation. The most commonly used models weren't built to capture a change in a firm's behavior."

While pricing behavior by businesses has been gradually aligning with the norm since the beginning of the year, Vincent emphasized that progress has been slow. The issue of corporate profits has gained attention in the post-pandemic period, as some have questioned the fairness of increasing profits amid high inflation. Research from the central bank suggests that price increases have closely mirrored the cost increases faced by businesses. However, Vincent pointed out that even if profit margins remain stable, it would imply that customers bear the entire burden of higher prices.

Vincent stated that these recent insights into pricing behavior's potential impact on inflation are prompting the Bank of Canada to reconsider its assumptions about the factors influencing inflation. He explained, "The impact of our recent discoveries shouldn't 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."

Vincent outlined certain risks associated with abnormal corporate pricing behavior in the context of the inflation outlook. Factors like increased labor and financing costs could continue to exert upward pressure on prices. Additionally, the unusual pricing behavior might become "sticky," with firms persisting in making frequent price adjustments even after the factors driving those changes have diminished. This stickiness could be attributed to technological advancements such as electronic price tags, which facilitate price increases, and industry consolidation, which may reduce competitive pressures that inhibit price hikes.

Vincent also highlighted the potential for recent pricing behavior to become self-perpetuating, as firms might continue the pattern of frequent price changes if they anticipate similar behavior from suppliers and competitors, creating a feedback loop in the pricing ecosystem.