The Pros and Cons of fighting Inflation with Competition Policy

The Pros and Cons conference 2023 commenced by the Swedish Competition Authority’s Director General, Rikard Jermsten welcoming the participants, giving an outline of the subject and an overview of the conference.

Jermsten stated that this year’s theme, the Pros and Cons of Fighting Inflation with Competition Policy, was not a hard pick. He reminded us about the historical high inflation that we have now and how it impacts consumers, companies and how citizens demand action from the governments. But also, the difficult situation and its implications for central banks´ work to stabilize prices. For competition authorities, it raises question about the role of competition and if better competition is part of the solution.

Jermstens message is that, even though a sudden loss in competition is not the primary cause to resent inflation, effective competition can facilitate adaptation and recovery. Crises are a reason to deal with and fix problems with competition. He believes that this must be kept in mind when discussion policy measures to deal with the crisis and mitigate the effects of rising livings costs for households.

Jermsten raised the importance of understanding the relationship between competition and inflation if competition is a part of the solution to the crisis. He continued by addressing the question that the Swedish Competition Authority will be commissioned by the Swedish government to answer: Who gets the extra 20 percent when we pay for food today compared to last year? The retailers, the wholesalers, the producers or the farmers? Results and policy recommendation will be presented by the authority within a year. The theme of the Pros and Cons conference 2023 conference is spot on this task.

Lars Magnusson, Professor of Economic History at Uppsala University, started by taking a look back on what our recent economic history can teach us regarding policy measures against inflation.
Magnusson stated that inflation is dependent on plenty of different factors often working in combination with each other and is therefore a complicated phenomenon that is difficult to combat. The successfulness of the measures taken to fight inflation also depends on the correctness of the interpretation of the real causes. He brought examples of the most common historical causes to past inflationary events and included examples of government’s bad habits of destroying their own money base through for example debasing, clipping coins and creating bank money at a too large of a scale. But he also discussed supply shocks such as bad harvests, climate changes, war, pandemics, market failures and bad policies creating disturbances of various kinds. He further drew the link to today’s inflation that is probably supply lead, caused by pandemics, war and market disturbances.

Moreover Professor Magnusson talked about what measures that have been used to fight inflation historically. First, monetary reforms have been a common measure to increase the value of money or changing supply of money. Magnusson continued with Keynesian macroeconomic finance and monetary policies, and thirdly he talked about price controls that now again are up on the policy agenda after its absence.

Magnusson stated that all measures used to curb inflation has its pros and cons. Answers to questions such as which measures to choose and mix of tools to use are complex. To Magnusson’s understanding, competition policy could be used more than it has to fight inflation, but mainly as a long-term commitment to increase the effectivity of the market economy in order to avoid supply shocks and increase competition.

Richard Friberg, Professor of Economics at Stockholm School of Economics, outlined what economic research tells us about the link between inflation and competition. He stated that inflation is a macroeconomic phenomenon, but from a microeconomic perspective there is potential questions to deal with. When competition is weak do prices increase more? And, does the strength of competition impact price levels? Threreafter, three research fields were presented as examples of where macroeconomic and microeconomic topics may overlap with regards to competition and inflation.

Firstly, Friberg introduced research on cost pass-through, which is the question about how much of changes in costs that is reflected in prices. The idea is that weaker competition gives higher pass-though. However, this statement is theoretically doubted. Weak competition implies that prices are already high. There is also little empirical evidence for the impact of competition on pass-through.

The second research field presented was the asymmetric response to cost shocks, i. e. the rockets and feathers argument. This is when prices do not fall as quick as they rise when costs are changing. One potential explanation is that the mark-up the firms want to reach, when in a tacit collusive scheme, comes closer when costs are reduced without prices changing, and further away when costs are increasing. Another explanation is about consumer’s intensity in searching at different levels of the price.

Thirdly, Friberg talked about the perception of fairness, which is a large literature in behavioural economics. It is about the difference in view of fairness regarding price increases due to cost shocks and demand shocks, where the first is seen as fair while the second one is seen as unfair.

Professor Friberg´s view is that when regarding inflation one should first have in mind all macroeconomic factors. But he also stated that a watchful competition policy is always important independent of inflation and for the price level of different markets the strength of competition matters.

The moderator Karl Lundvall from the Swedish Competition Authority started by introducing the subject. He described the paradox that experts do not see strong evidence regarding the link between inflation and competition, but during times of high inflation competition use to be on the top of the agenda.

The first speech was held by Martin Flodén, Deputy Governor at the Riksbank. He did not deny that competition is important for efficiency which can lower prices, but weak competition is not the reason for the inflation that we see today. According to Flodén, competition should always be promoted, but it is not a substitute to monetary policy.
Next up was Tina Søreide, Director General at the Norwegian Competition Authority. She stated that weak competition is not to blame for high prices, but it plays its part. Competition might matter for expectations of high inflations and adaptability. Søreide also lifted up the perspective that strong competition can reduce the influence from powerful players.

The last speech of the first panel was held by Páll Gunnar Pálsson, Director General at the Icelandic Competition Authority. He echoed the point made by the previous speakers that weak competition is not to blame for the recent price increases. But Pálsson also pointed out the importance of promoting competition in order strengthen the resiliency of the economy.

In the open discussion, Pálsson stated that he sees situation as an opportunity. The Icelandic Competition Authority have had meetings with companies in Iceland about what can be changed and have encouraged the government to work for a competitive environment. The Icelandic Competition Authority also has a good relationship with the Icelandic Central Bank, where they share each other’s perspective.

Søreide said that it is a great opportunity for competition economists and macroeconomists to speak more, and continued that she had a good experience from a meeting the Norwegian Competition Authority had with the Norwegian Central Bank. She also sees the situation as an opportunity to discuss what tools and resources competition authorities needs in its work.

Flodén sees the current situation as a challenge for a central bank rather than an opportunity. But it is an opportunity for competition authorities to get attention. Attention should also be given to the power of the consumer. A task that central banks and competition authorities have in common is to increase the understating of price setting behaviours.

The questions asked were if the various policy responses proposed to deal with the crises may put competition at risk? Are price-caps always bad? Can agreements among competing firms to refrain from price increases be problematic?

Ana Sofia Rodrigues, Chief Economist at the Portuguese Competition Authority, started by noting that the debate has come a long way in the past year and a half. In the beginning, there were those pointing towards lack of competition being the main trigger for the recent high inflation. Although, this debate has now moved on.

Rodrigues remarked that we all share the concern that policymakers have about the impact of inflation. At the same time, measures to address these concerns may unintendedly have negative effects. It is important to design the measures to minimize these costs. Rodrigues explained that the Portuguese Competition Authority has worked to advise policymakers on this. They have, for example, advised that price controls may distort markets and that state aid must be designed to be competitively neutral.

Commenting on already implemented policy measures, Rodrigues argued that support to households is less likely to have negative effects on competition. In contrast, Rodrigues argued that the price controls implemented in the electricity sector risks having distortionary effects.

Pierre Régibeau, Chief Competition Economist at DG Competition, began his remarks by concluding that there are traditional tools, such as monetary policy, to deal with inflation. But he then noted that there may be a link between monetary policy and competition policy. Monetary policy works better when markets function well. Régibeau stated that when monetary policy does not show results fast enough, the response from policymakers tends to be price controls. While price controls may have long-term negative effects, he argued that there are situations when price controls could be a good idea in the short run. For examples, they might be used to help vulnerable households or smooth out extreme price increases over a longer time period.

Régibeau then discussed the phenomenon of “rockets and feathers”, where cost increases affect prices faster than cost decreases. He noted that some blame has been put on a lack of competition, but he argued himself that this is not related to competition. He also discussed a lack of resilience in the economy. The incentives of individual firms to diversify their risks are probably too low, motivating a policy response. However, the act of designing such measures are difficult.

Ioannis Lianos, President at the Hellenic Competition Authority, started by commenting that the discussion so far had had a consensus that inflation was to be solved by monetary policy. After this, he discussed research showing that profits drive a significant part of today’s inflation and that inflationary shocks can have permanent effects. Lianos argued that competition policy can have a complementary role in fighting inflation in the short- or medium-term. In particular, competition authorities have a role in advising policy makers on how to design policy measures that do not damage competition.

Lianos then listed other possible tools available to competition authorities. Enforcement is always possible, but it takes time for it to show results. Among more immediate tools, the Hellenic Competition Authority has mapped several problematic sectors and started a market investigation in one of them, (the sector of Fuels). Lianos also remarked that this inflationary period may be an ideal time to argue for increased powers for competition authorities. The Hellenic Competition Authority recently gained the power to intervene against a wider set of anticompetitive behaviour, for example certain price signalling.

The panel discussed whether inflation can weaken competition. Does less price transparency make consumers less demanding and more prone to accept higher prices, allowing firms to pass on more than what is motivated by higher costs to consumers?

Antonio Buttà, Chief Economist at the Italian Competition Authority, argued that the discussion today echoes the one from 15 years ago. This is particularly evident regarding the price of several agricultural goods and cost shocks through asymmetric pass-through in the value chain, both at the European and national levels. He suggested revisiting studies on specific supply chains when looking at possibly similar supply chain problems today. He has not found any evidence so far that inflation leads to weaker competition or cartels.

Linda Gratz, Director at E.CA Economics, suggested that there might arise certain circumstances within the context of inflation that would give rise to a risk of more coordination. The uncertainty in the market may increase the incentive to talk to one's competitors, create excess capacity, reduce the probability of entry, and reduce the willingness to exit the market. Furthermore, the consumers anchoring to what a goods inputs actually cost reduces. However, inflation also makes it harder to coordinate around focal points. Therefore, one should be vigilant towards indexation of prices to inflation, as well as freight surcharges. However, this should only be collusive if the firms collude on the indexation or surcharges.

Vanessa Turner, Senior Advisor at BEUC, turned the discussion toward the cost of living crises that are hitting many European consumers at the moment. Furthermore, there have been cases in Germany where the consumers' rights to compare goods at unit price costs has been obstructed by food retailers, in turn raising the search cost for consumers. The main tool to curb inflation is monetary policy, but competition policy is also important. The NCAs should prioritize collusion cases that have the most direct harm towards consumers, increase publicity efforts in these cases for deterrence purposes, as well as overhaul the exceptions on sustainability grounds.

Antonio Buttà presented the Italian authority's perspective on the subject - what matters is that the NCA keep doing their job since the best approach to limiting anti-competitive behaviour is what we have done in the past. The best way to prevent cartels in the future is to be resolute and continue to provide a general deterrence against cartel formation.

Finally Linda Gratz touched upon the theme of the overall discussion of the conference and stated that lack of competition is not driving inflation. This statement was echoed by both Antonio Buttà and Vanessa Turner. Vanessa Turner raised some concerns with merger control and pointed out that it might be necessary to strengthen merger control law. Furthermore, she pointed to the market investigation tool to fix market failures. Linda Gratz commented that the market investigation tool may be effective