Market Power and Monetary Policy

Abstract

In this paper we explore the link between monetary policy and market power. We start by establishing several facts on market power in UK markets using micro data. First, while no clear trend emerges for market concentration, market power measured by markups estimated at the firm level have clearly increased in recent years, with the rise being reasonably broad-based across sectors. Second, we show that the increase is heavily concentrated in the upper tail of the distribution -companies whose mark-ups are in, say, the top quartile. Third, internationally-oriented firms are the driving force behind the rise in markups. Fourth, following Díez et al (2018), we find some reduced-form evidence of a non-monotonic relation between markups and investment at the firm level, with high levels of markups being associated with lower investment. Having established these facts, we show that the Phillips curve becomes steeper in the textbook New Keynesian model when firms tend to have more market power, reducing the sacrifice ratio for monetary policy. As inflation becomes less costly in an economy with high market power, however, the optimal targeting rule for monetary policy also changes. A rise in both the trend and volatility of mark-ups may lead to a significant rise in inflation variability. But a secular rise in mark-ups by itself improves monetary policy's ability to stabilise inflation without inducing large movements in output.

Inequalities in the twenty-first century: Introducing the IFS Deaton Review

“…Similar trends have been observed in the US (Autor et al, 2017;De Loecker and Eeckhout, 2017). In both the UK and the US, the rise in average markups appears to be driven by a small number of highly profitable firms (De Loecker and Eeckhout, 2017;Aquilante et al, 2019). network effects and economies of scale.…”

“…Another trend in recent decades is the rise in product market concentration. The share of all turnover captured by the largest 100 firms in the UK has risen by more than a third since the late 1990s ( Figure 13; Aquilante et al, 2019). Average company markups, which measure the extent to which prices exceed marginal costs (the cost of producing an additional unit), have also risen since the 1980s (Figure 13; De Loecker and Eeckhout, 2018).…”

Markups and Inflation Cyclicality in the Euro Area

“…In this case, no single firm is sufficiently large to have a significant bearing on others' behaviour. Aquilante et al [2019] find in such a setup that the higher the degree of market power and the markups firms charge, the more cyclical inflation becomes. However, monopolistic competition assumes there is no strategic interaction between firms.…”

Product Market Structure and Monetary Policy: Evidence from the Euro Area

“…monopolistic competition, Calvo pricing, no strategic interactions), the Phillips curve steepens with higher markups. This implies that the sacrifice ratio falls, the cost of high inflation lower, which may lead to a different optimal rule, allowing for more absorption through inflation than output gap (Aquilante et al, 2019). Similarly, the level of the markup, in so far as it impacts investment growth would also affect r * , the equilibrium interest rate.…”

“…Similarly, the level of the markup, in so far as it impacts investment growth would also affect r * , the equilibrium interest rate. In terms of market concentration, if the economy is characterized by firms that have such significant profits and cash reserves that they become interest insensitive, then the slope of the Investment-Spending (IS) curve attenuates, rendering monetary policy less potent in moving aggregate demand (Aquilante et al, 2019).…”