The granular origins of inflation

Summary

Focus

We show that over recent decades, overall inflation has been shaped substantially by idiosyncratic variation in the prices set by large firms and key product categories. Using 2.9 billion barcode-level transactions from 16 advanced and emerging market economies, we disentangle inflation into a macro component plus "granular" components at the firm and product category levels. By doing so, we clarify how market structure and firm-level behaviour interact with macroeconomic factors to shape overall inflation dynamics.

Contribution

While previous research has focused mainly on broad, aggregate forces driving inflation, we highlight the importance of granular influences. We develop a decomposition method to track the distinct contributions of individual firms and product categories alongside macro-level trends. We also show that the significance of these granular forces depends on the degree of market concentration and the prevailing inflation environment.

Findings

Our analysis reveals that inflation in advanced economies is highly granular, ie significantly influenced by the prices set by a small number of large firms. For advanced economies between 2005 and 2020, the firm-level granular component accounts for 41% of inflation variance. Most of this – 26 percentage points – is attributable to the 10 largest firms. These price changes at the level of product categories explain an additional 20% of inflation variance.

In contrast, in emerging markets, where inflation is on average higher and market shares are less concentrated, granular contributions play a more modest role.

During the 2021–22 post-Covid inflation surge, the influence of granular forces intensified in advanced economies, with roughly one third of the surge traceable to large-firm dynamics. Overall, our findings highlight that granular factors beyond traditional macroeconomic determinants matter greatly in shaping inflation.

Abstract

This paper uses barcode-level price data for 16 advanced and emerging market countries over the period 2005–2022 to investigate the role of individual firms and product categories in aggregate inflation. We decompose inflation into the component due to macroeconomic shocks and the granular residuals capturing the impact of individual firms and product categories, respectively. In advanced economies, the firm granular residual accounts for 41% of the variance of overall inflation, while the product category granular residual accounts for another 15%. Most of the variation in the firm granular residual is due to idiosyncratic shocks rather than to higher sensitivity of larger firms to common shocks. In the cross-section of countries, granular residuals are less important in economies with less concentrated market shares and higher inflation, such as emerging markets. Lastly, granular residuals contributed to the post-COVID inflation surge, with the firm-level component accounting for roughly one-third of the 2021-2022 inflation in advanced economies.

JEL classification: E31, E32, L11, L16

Keywords: inflation, price setting, firm-level shocks, granular fluctuations, large firms