Working Paper: CEPR ID: DP18436
Authors: Frederick van der Ploeg; Tim Willems
Abstract: After the post-Covid rise in inflation, a debate has emerged whether this inflation is "seller-driven" and, if so, how policy should respond. We build a model to capture the underlying distributional conflict between wage- and price-setters both wishing to attain a certain markup. We highlight a new "aspirational channel" of monetary transmission: by influencing cyclical conditions, a central bank can control inflation through affecting markup aspirations of workers and firms. We establish conditions under which an inflationary situation characterized by inconsistent aspirations requires a reduction in economic activity, to push demands of workers and firms towards consistency. We find that countercyclical markups and/or a flat Phillips curve call for more "dovish" monetary policy (responding less to inflation deviations, more to the output gap). Estimating price markup cyclicality across 43 countries, we find that contractionary monetary shocks indeed have stronger anti-inflationary effects in countries with greater markup procyclicality.
Keywords: Taylor principle; inflation; wage-price dynamics; markup cyclicality; monetary policy transmission
JEL Codes: E31; E32; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy (E52) | Inflation (E31) |
| Monetary policy actions (E52) | Markup aspirations of workers and firms (J39) |
| Markup aspirations of workers and firms (J39) | Inflation (E31) |
| Contractionary monetary shocks (E49) | Anti-inflationary effects (E31) |
| Markup procyclicality (E32) | Effectiveness of monetary policy (E52) |
| Countercyclical markups (E32) | Monetary policy stance (E63) |