Endogenous Firm Competition and Cyclicality of Markups
The cyclicality of markups is crucial to understanding the propagation of shocks and the co- movement of macroeconomic variables. I show that the degree of inertia in the response of output to shocks is a fundamental determining factor for the cyclicality of markups in a broad class of models. In particular, markups follow a forward looking law of motion in which they depend on firms’ conditional expectations over the net present value of all future changes in output. I test this law of motion with data for firms’ expectations and find that, across different types of microfounded models of cyclical markups, the behavior of firms is most consistent with implicit collusion models. Calibrating an implicit collusion model to the U.S. data, I find that markups are procyclical when the model matches the observed inertial response of output to shocks, as commonly found in the data.
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