Markups and monetary policy
In this paper, van der Ploeg and Willems, explore the concept of “conflict inflation,” (a concept also explored by Lorenzoni and Werning (2023) in “Inflation is a conflict”) which arises from a distributional conflict between wage and price-setters, both aiming to attain a certain markup over their costs. This conflict has become more prominent post-Covid due to strong wage growth accompanying the rise in inflation. The authors introduce the idea of an “aspirational channel” of monetary policy transmission, which suggests that central banks can influence the economy by creating conditions that moderate the competing claims of workers and firms, ensuring consistency with the total size of the economy. Van der Ploeg and Willems establish that in situations where aspired markups are cyclically sensitive, an inflationary situation characterized by inconsistent aspirations may require a reduction in economic activity to eliminate worker-firm disagreement over the appropriate level of the real wage. The authors use a dynamic new-Keynesian model, where workers and firms may disagree over the real wage and featuring cyclically sensitive markups. They find:
- Procyclical markups: If flexible price/wage markups are procyclical, a monetary contraction can lower inflation by reducing the aspirations of workers and/or firms, leading them to settle for a lower markup. Economic slack, such as unemployment or the output gap, plays a role in moderating unrealistic aspirations.
- Countercyclical markups: If markups are countercyclical, an aggressive central bank response to inflation may create indeterminacy, especially if the Phillips curve is flat. In such cases, monetary policy may need to be more accommodating towards inflation to produce a determinate equilibrium or place a bigger weight on the output gap, essentially adopting a more dovish stance.
Battle of the markups: conflict inflation and the aspirational channel of monetary policy transmission
Authors: Frederick van der Ploeg, Tim Willems
From: University of Oxford, Bank of England
Cyclicality of profits in a heterogeneous-agent setup
In this paper, Bilbiie and Känzig investigate the relationship between corporate profits, income distribution, inflation, and aggregate demand within the New Keynesian framework. Amidst rising inflation, the authors explore whether increased corporate profits and the narrative of corporate greed are significant contributors to inflation and how they influence aggregate demand. The key findings of the paper are:
- Procyclical Profits and Inflationary Conditions: The paper derives a novel analytical condition showing that profits can be procyclical and inflationary if wages are relatively stickier than prices. This condition is crucial for understanding the propagation of shocks in New Keynesian models.
- Countercyclical Profits and Aggregate Demand: For aggregate demand fluctuations and inflation to be amplified by household heterogeneity, profits must be countercyclical. However, this is inconsistent with empirical data, which generally shows procyclical profits.
- Investment Channel Over Profits: Adding physical capital investment to the model can resolve the inconsistency between procyclical profits and aggregate demand amplification. The amplification occurs through an investment channel rather than through profits, suggesting that the narrative attributing elevated inflation to corporate greed is not supported by macroeconomic theories.
- Policy Implications: The findings suggest that policies such as price controls aimed at curbing “sellers’ inflation” may not be effective if they do not address the underlying dynamics of profits and investment in the economy.
Bilbiie and Känzig conclude that the commonly held view that higher inflation is associated with or caused by higher corporate profits is incompatible with standard macroeconomic theories. Instead, they argue that inflation dynamics and aggregate demand amplification are more complex and are influenced by factors such as investment and the cyclicality of profits, rather than corporate greed alone.
Greed? Profits, Inflation, and Aggregate Demand
Authors: Florin O. Bilbiie, Diego R. Känzig
From: University of Cambridge, Northwestern University
