Cooking the Books 2 – What the market will bear
Some people think that businesses can fix at will the price of what they sell. Among them, it seems, is the Governor of the Bank of England. After announcing on 23 March an increase in the Bank rate to 4.25 per cent, Andrew Bailey asked business to ‘please’ not increase their prices. As the headline in the Guardian the next day reported, ‘Bank of England boss urges firms to hold back price rises or risk higher rates’. His argument was that ‘if all prices try to beat inflation we will get higher inflation’ and that, if that happened, the Bank would have to increase the Bank rate to an even higher level.
It may seem surprising that the Governor of the Bank of England should not understand how businesses operate, but then finance is a bit isolated from the real world of production. Patrick Hosking, the Financial Editor of the Times, was particularly scathing in his column on 28 March:
‘Surely, when first introduced to an economics textbook, Bailey learnt that firms are not driven by altruism or patriotism but by market forces and profit? They will charge what the market will bear. If possible, they will go further, ever on the lookout for, in Adam Smith’s immortal phrase, “some contrivance to raise prices.” It’s a boardroom instinct as natural as breathing. While modern-day corporations have to consider many stakeholders, they still see their prime duty over the long run to maximise profits for the shareholders’.
In other words, if they can increase prices without jeopardising sales and so profits they will; otherwise, they won’t. It all depends on market conditions for what they are selling. Hoskins reckoned that for the time being the market for most goods can still ‘bear’ a price increase. But this might not necessarily continue:
‘Until businesses see more capitulation by their customers, the price escalation will go on. Businesses will stop lifting their prices only if enough customers defect to competitors, trade down to cheaper lines or find near-substitutes. Or stop buying at all. For the poorest households, this has happened already’.
There is some evidence that people have been trading down, buying in Tesco and Sainsbury’s instead of Waitrose, or else in Lidl and Aldi instead of Tesco and Sainsbury’s. So, if prices do stop rising so much this will not be because Bailey’s plea was listened too, but because the limits of ‘what the market will bear’ would have been reached.
This, incidentally, explains why businesses cannot automatically pass on a wage increase. Sometimes they can, but sometimes they can’t. It depends on market conditions.
In any event, businesses can’t cause inflation in the proper sense of the term — a rise in the general price level due to a depreciation of the currency — but Bailey wasn’t using the word in that sense but in the simplistic sense in which it has come to be widely used of an increase in the consumer price index. An increase in the price at which businesses sell consumer goods and services, for whatever reason, will cause an increase in ‘inflation’ in that sense because it will cause the index to go up. But that’s by definition. And, equally by definition, if businesses don’t increase their prices then there won’t be ‘inflation’. So Bailey was calling on businesses not to increase prices so that prices don’t increase. How very profound.