When prices started rocketing up two years ago, central banks underestimated how stubborn the inflation would be. Now, some economists believe they understand why: companies are taking advantage of a unique opportunity to increase their profit margins.
Consumer prices in the eurozone were 7.0% higher in April than they were a year ago, up from March and above the European Central Bank's objective by more than three times, according to data issued by the European Union's statistics agency on Tuesday. The core rate of inflation, which does not include the cost of food and energy, however, decreased from a record high of 5.7% in March to 5.6% in April.
Despite a wave of interest-rate increases that have gone higher and been delivered more swiftly than at any other time since the 1980s, inflation rates continue to be uncomfortably high in the U.S. and many other countries across the world.
Businesses recently increased their rates for a number of valid reasons. Costs have increased as a result of the Covid-19 pandemic's impact on the supply chain and the shortages of gasoline, food, and raw materials that followed Russia's invasion of Ukraine.
However, there are indications that businesses are making more money than just covering their expenses.
Economists at the European Central Bank claim that companies have inflated their profits. They said that this was a stronger driver of inflation in the second half of last year than pay growth.
Jan Philipp Jenisch, chief executive officer of construction materials maker Holcim, said on a recent earnings call: “We are in that inflationary environment already for almost two years now…We have done the pricing in a very proactive way, so that our results aren’t suffering. On the contrary, they are improving the margins.”
One puzzle is why consumers have played ball. Usually, economists would expect any business that raised its prices to lose customers to competitors that don’t, or not by as much.
But these aren’t normal times. In rare situations—such as an economy’s reopening after a pandemic—widespread knowledge that costs are rising allows businesses to raise their prices knowing that their competitors will act in the same way, according to a paper by Isabella Weber, Assistant Professor of Economics at the University of Massachusetts, Amherst and her colleague, Evan Wasner.
That is a pattern the two economists said has played out in an analysis of recent earning calls in which executives at U.S. businesses present their financial results to analysts.
“We do have to think about pricing differently,” said Ms. Weber. “A cost shock, or bottlenecks can create an implicit agreement among firms that raise their prices, so they can expect others to act likewise.”
Consumers have also been unusually willing to accept higher prices lately. Paul Donovan, chief economist at UBS Global Wealth Management, said businesses are betting that consumers will go along because they know about supply bottlenecks and higher energy prices.