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How price setting influences inflation

Deputy Governor Nicolas Vincent talks about how companies set their prices, how those practices changed during the pandemic and why this remains a risk for inflation.

Watch Deputy Governor Vincent speak to the Chamber of Commerce of Metropolitan Montreal. Read the full speech.

The pandemic changed how firms set their prices

When COVID-19 restrictions lifted worldwide, demand for goods and services outstripped supply. Russia’s invasion of Ukraine added to the constraints. With input costs rising and customers willing to pay more, firms were able to raise prices more often—and by larger amounts—than usual.  

In ordinary times, prices are sticky. Companies typically don’t adjust prices often, even if input costs change or consumer demands shift. Why not? Because it can be expensive to change prices:

  • Managers need to assess input costs and consumer demand.
  • They also need to consider competitor prices and determine whether a price change would prompt clients to move their business elsewhere.
  • Using that information, they have to determine the new optimal price, implement it and communicate the change to clients.
  • These steps come at a cost, which may outweigh the potential benefit of a price change.

But during the recovery from the pandemic, firms were faced with fast-rising input costs and they saw that consumers had less choice because supply was low everywhere. This allowed them to pass those changes on to consumers more quickly and more fully than usual.

We believe that this behaviour by firms—both here and abroad—is intimately linked to the stronger-than-expected inflation we’ve seen.”

So how is pricing working now?

Pricing behaviour is stabilizing, but it is still not back to pre-pandemic norms.

Bank of Canada surveys show that, since the beginning of this year, companies have been talking less about “hot demand” and seem to be paying more attention to their competitors again. And by analyzing information companies provide, we also see signs that pricing behaviour is normalizing. However, mentions of high labour and financing costs are still more common than before the pandemic.   

Another risk is that the new pricing behaviour itself could become sticky. Some grocery stores, for example, are now using electronic price tags to reduce the cost associated with changing prices. And consolidation is making some industries less competitive.  

The biggest risk is that the recent practice of changing prices more often and more sharply could become the norm. If stores expect their suppliers and competitors to change prices more frequently, and consumers are willing to continue paying higher prices rather than shopping around, then it creates a feedback loop. This could make prices more sensitive to shocks, making it more difficult to get inflation back to our 2% target.

In other words, if recent pricing behaviour settles into a new normal, it could complicate our return to low, stable and predictable inflation.”

Price setting needs to get back to normal

Inflation has come down sharply from a peak of about 8% in June 2022. The cost of many inputs is no longer rising as quickly as before and, in some cases, has fallen, though it is still uncertain how swiftly lower input costs will be passed on to consumers. 

Ultimately, the pandemic-related shifts in corporate pricing behaviour show how important it is that we get inflation back to our target. When inflation is low and stable, consumers are more likely to notice price changes, and this forces businesses to be more careful about what cost changes they pass on.

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