Identifying a permanent markup shock and its implications for macroeconomic dynamics

A permanent (price) markup shock is justified using an industry-based model in which an increase in market concentration raises the desired markup. Moreover, evidence in favor of the non-stationarity of the markup is presented, which in turn implies that per capita hours are also non-stationary. Structural vector autoregressions are then constructed that can identify shocks to the markup, technology and the federal funds rate. The results show that (1) inflation responds immediately to shocks to the markup and technology whereas it displays a hump-shaped response to a monetary policy shock, and that (2) per capita hours decline in response to positive shocks to the markup and technology. These empirical findings have important implications for macroeconomic dynamics, including the issues on inflation inertia and the technology-hours debate. The paper also points out that the dynamics of the economy cannot be correctly explained without consideration of the permanent markup shock. Finally, the approach in this paper suggests several ways to identify a wage markup shock using structural vector autoregressions.