Is Inflation Good for Business? The Firm-Level Impact of Inflation Shocks in the Baltics, 1997-2021

IMF Working Papers, March 1, 2024

Source details

Canonical URL: Is Inflation Good for Business? The Firm-Level Impact of Inflation Shocks in the Baltics, 1997-2021

Study period: 1997 and 2021.
Using a large panel of firm-level data, the paper analyzes effects of inflation shocks on total factor productivity (TFP), gross profitability, and net fixed investment in nonfinancial sectors.
Main empirical conclusions:
- Inflation and inflation volatility had mixed effects on TFP growth, profitability, and net fixed investment in the first year as well as over the medium term, albeit at a dissipating rate.
- Inflation shocks had differential effects on large versus small firms.
- Significant variation in firm responses across tradable and non-tradable sectors.
- Estimates from a state-dependent model indicate firms’ responses to inflation shocks varied with the state of the economy.
Mechanisms suggested by the results:
- Nonfinancial firms in the Baltics appear to adjust to inflation shocks by either transferring higher production costs to consumers or substituting inputs.

Large versus small firms:
- Inflation shocks produced differential effects across firm-size subsamples (large firms versus small firms).
- The paper documents heterogeneous outcomes in TFP growth, profitability, and net fixed investment depending on firm size.

Tradable and non-tradable sectors:
- The response to inflation shocks varies significantly across sectors classified as tradable versus non-tradable.
- Sectoral variation affects TFP growth, profitability, and net fixed investment differentially.

Business-cycle or state dependence:
- A state-dependent model reveals that the impact of inflation shocks on firms depends on the macroeconomic state.
- Firms’ adjustment strategies and magnitudes of response differ across states of the economy.

Agility of firms:
- Nonfinancial firms in the Baltics have been agile in adjusting to inflation shocks.
- Observed adjustments likely reflect price pass-through to consumers or input substitution strategies.
External validity caveat:
- Given differences in the level and nature of the recent inflation shock and the sample period analyzed, the empirical findings presented in this paper might not necessarily apply to the latest bout of inflation in the Baltics.

IMF Working Paper No. 2024/043 by Serhan Cevik, Alice Fan, and Sadhna Naik, March 1, 2024.