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Inflation, Markups and Monetary Policy

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  • Jonsson, Magnus

    ()
    (Research Department, Central Bank of Sweden)

  • Palmqvist, Stefan

    ()
    (Monetary Policy Department, Central Bank of Sweden)

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    Abstract

    The correlation between persistent changes in the markup in one sector of an economy and the inflation rate is quantified in a 2-sector dynamic general equilibrium model. How this relationship is affected by monetary policy is also studied. We find that the correlation is in general positive under an exogenous money growth rule as well as under an inflation targeting rule. That is, a decrease of the markup leads to a decrease in the CPI-inflation rate. However, if inflation is measured by an optimal price index that also includes the wage rate the correlation is slightly negative. That is, a decrease in the markup leads to higher inflation rates. This is due to higher wage rates. The correlation is sensitive to whether the policy rule includes an output term. If monetary policy accommodates output strongly the correlation is negative. A decrease in the markup leads to higher inflation rates, as measured by both the CPI and the optimal price index.

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    Bibliographic Info

    Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 148.

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    Length: 30 pages
    Date of creation: 01 Apr 2003
    Date of revision:
    Handle: RePEc:hhs:rbnkwp:0148

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    Keywords: Price indices; monopolistic competition; monetary policy rules;

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    References

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    1. Gary D. Hansen & Edward C. Prescott, 1992. "Recursive methods for computing equilibria of business cycle models," Discussion Paper / Institute for Empirical Macroeconomics 36, Federal Reserve Bank of Minneapolis.
    2. Svensson, Lars E.O., 1997. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," Seminar Papers 615, Stockholm University, Institute for International Economic Studies.
    3. Katharine S. Neiss, 2001. "The markup and inflation: evidence in OECD countries," Canadian Journal of Economics, Canadian Economics Association, vol. 34(2), pages 570-587, May.
    4. Anindya Banerjee, 2001. "Industry structure and the dynamics of price adjustment," Applied Economics, Taylor & Francis Journals, vol. 33(15), pages 1889-1901.
    5. Mankiw, N. Gregory & Reis, Ricardo, 2002. "What measure of inflation should a central bank target?," Working Paper Series 0170, European Central Bank.
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    7. Blanchard, Olivier Jean & Kiyotaki, Nobuhiro, 1987. "Monopolistic Competition and the Effects of Aggregate Demand," American Economic Review, American Economic Association, vol. 77(4), pages 647-66, September.
    8. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
    9. Robert S. Chirinko & Steven M. Fazzari, 2000. "Market Power and Inflation," The Review of Economics and Statistics, MIT Press, vol. 82(3), pages 509-513, August.
    10. Charles T. Carlstrom & Timothy S. Fuerst, 2001. "Real indeterminacy in monetary models with nominal interest rate distortions: the problem with inflation targets," Working Paper 9818R, Federal Reserve Bank of Cleveland.
    11. Gerlach, Stefan & Svensson, Lars E. O., 2003. "Money and inflation in the euro area: A case for monetary indicators?," Journal of Monetary Economics, Elsevier, vol. 50(8), pages 1649-1672, November.
    12. Hornstein, Andreas, 1993. "Monopolistic competition, increasing returns to scale, and the importance of productivity shocks," Journal of Monetary Economics, Elsevier, vol. 31(3), pages 299-316, June.
    13. Benabou, Roland, 1992. "Inflation and markups : Theories and evidence from the retail trade sector," European Economic Review, Elsevier, vol. 36(2-3), pages 566-574, April.
    14. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
    15. Smets, Frank & Wouters, Raf, 2002. "An estimated stochastic dynamic general equilibrium model of the euro area," Working Paper Series 0171, European Central Bank.
    16. Uhlig, H., 1995. "A toolkit for analyzing nonlinear dynamic stochastic models easily," Discussion Paper 1995-97, Tilburg University, Center for Economic Research.
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    Cited by:
    1. Marco Vega & Diego Winkelreid, 2005. "How Does a Global Disinflation Drag Inflation in Small Open Economies?," Working Papers 2005-001, Banco Central de Reserva del Perú.

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