The Relationship between Competition and Inflation

Abstract

This study supplements previous empirical work on the relationship between the average rate of inflation and competition by adding a new approach for estimating markups and investigating the annual rate of inflation, price variance and price levels. Subject to certain qualifications, markups can be interpreted as indicators for competition intensity. Our calculation, conducted for 15 countries and 34 sectors, exhibits major differences between the sectors within one country and among the same sectors across various countries. The markups are used to produce estimates of the relationship between competition and inflation (average and annual rates), price levels and price variance. Although a significantly negative correlation with inflation and price variance is evident for the period from 1991 to 2005, competition loses its explanatory power for inflation rates when longer time spans are considered. In terms of economic policy, this study confirms the findings of previous works which identify the intensification of competition as a temporary means of curbing price increases. A new finding from this study is the evidence for the inflation-stabilizing effect of intensified competition, which is caused by its negative correlation with price variance. The fact that no significant relation between price level and competition intensity was found may be attributable to insufficient data.

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