Does monopoly power cause inflation? (1968 and all that)

Here's a question for you: Suppose there is a permanent increase in monopoly power across the economy (either firms having more monopoly power in output markets, or unions having more monopoly power in labour markets). Would that permanent increase in monopoly power cause a permanent increase in the inflation rate?

Most economists today would answer "no" to that question. It might maybe cause a temporary once-and-for-all rise in the price level, but it would not cause a permanent increase in the inflation rate. The question just sounds strange to modern economists' ears. They would much prefer to discuss whether a permanent increase in monopoly power caused a permanent reduction in real output and employment. What has monopoly power got to do with inflation?

To economists 40 or 50 years ago, the question would not have sounded strange at all. Many (maybe most?) economists would have answered "yes" to that question. A permanent increase in firms' monopoly power leads firms to raise prices relative to wages, and then wages increase in response to the increase in prices, and then firms raise prices again,...so we get a price-wage spiral. And a permanent increase in labour unions' monopoly power leads unions to raise wages relative to prices, and then prices increase in response to the increase in wages, and then unions raise wages again,...so we get a wage-price spiral. There was cost-push inflation and demand-pull inflation, and monopoly power is an example of cost-push inflation.

Few economists talk like that and think like that nowadays. I suspect that many young economists (heterodox/Post Keynesians aside) won't even know what I'm talking about. So let me try to explain it to you.

Forget about targeting inflation. Suppose that monetary policy (and/or fiscal policy) targets something called "full employment output". Now the old guys were very fuzzy about exactly how they defined "full employment output", but that doesn't matter for our purposes. It's just some level of output Y^, and the job of the central bank is to target Y^, which means doing whatever they need to do to make the Aggregate Demand curve vertical at Y^. (Stick Y^ into the Taylor Rule, instead of potential output Y*, with a really big coefficient in front of Y-Y^, and a coefficient of zero in front of the deviation of inflation from target, because there isn't an inflation target.)

Suppose initially the economy starts out in equilibrium with 0% actual and expected inflation, and with "full-employment" target Y^ exactly the same as "potential output" Y*. Then there is a permanent increase in monopoly power, which causes a permanent fall in Y*. (That's what happens in a New Keynesian model when the representative firm's demand curve becomes less elastic, unless the labour supply curve is perfectly inelastic, because the equilibrium markup of prices over wages rises, so equilibrium real wages fall, so the natural rates of employment and output fall.) But the central bank's target stays the same at Y^. We get an increase in inflation, because any firm touched by the Calvo fairy will want to raise its price relative to other firms' prices.

But any young macroeconomist who has followed along so far should now be feeling deeply uneasy. If the long run Phillips Curve is vertical at Y*, and the central bank makes the AD curve vertical at Y^, then if by sheer fluke Y* and Y^ are exactly equal, the equilibrium inflation rate is indeterminate. And if Y* and Y^ are not equal there exists no long run equilibrium inflation rate at all. My thought-experiment doesn't make sense.

Something must have happened in the last 40 or 50 years that made economists think about this question so very differently. What was it?

I say "Milton Friedman happened". Specifically, Friedman 1968 (pdf) is what happened, though it took time for the message to get through (it always does), and some never got the message (some never do). It does not matter that Milton Friedman made a complete dog's breakfast of defining what exactly he meant by "the natural rate of unemployment"; all that mattered is that it was determined by real forces alone. So targeting "full employment" (which also got the complete dog's breakfast treatment in attempts to define exactly what it meant) made no sense at all. If by sheer fluke "full employment" was defined empirically exactly equal to the underlying unobserved theoretical construct "natural rate", any inflation rate was an equilibrium. And if they weren't equal, long run equilibrium did not exist.

If you think in terms of monetary policy (and/or fiscal policy) targeting "full employment" then it is perfectly natural to think of an increase in monopoly power causing inflation. Unless the central bank changes its target to offset it. But if you think of unemployment being determined in the long run by some "natural rate", then it makes no sense to think of the central bank targeting "full employment", whatever that might mean, because that is something monetary policy cannot do. Friedman 1968 was about what monetary policy cannot do.

Friedman wanted to replace the vertical AD curve (target "full employment") with a downward-sloping AD curve (target k% M2 growth). That was tried and rejected, but policymakers then went even further to the other extreme, by making the AD curve horizontal (target k% inflation). Which creates its own, different, problems. A sensible compromise between the two extremes is a downward-sloping AD curve that adjusts for shifts in velocity (target k% NGDP).

Now Thomas Palley and I disagree on how we would answer the question I started with. But we very much agree on the source of our disagreement:

"Recognising that the inflation of the 1970s was the result of a price-wage spiral triggered by conflict with unions over income distribution, compels rejection of the theory of the natural rate of unemployment. This theory has dominated economists' thinking about inflation for over a generation and has twisted public thinking.

The late Milton Friedman was the originator of the theory of the natural rate of unemployment, yet according to Friedman unions have absolutely nothing to do with inflation. Instead, inflation is everywhere and always an exclusively monetary phenomenon. For Friedman, the only role of unions is to increase unemployment, which fundamentally contradicts the union wage-price spiral story of inflation.

That means if the union price-wage spiral story of inflation is correct (which it is), Friedman's natural rate theory is wrong and policymakers should abandon it. Instead, the focus of policy can formally return to probing the boundaries of full employment.

Moreover, since inflation involves conflict over income distribution, there remains an unsolved policy challenge of how to fairly distribute income at full employment without triggering inflation."

Thomas wrote that in 2008. Yet when I read it now, it's like having an, errr, flashback to the 1970's.

Because it wasn't just "heterodox" macroeconomists who used to argue like that. Read James Tobin, writing as late as 1983 in "The case for Incomes Policies", who saw inflation at less than "full employment" as a negative externality to which the appropriate response was one of: direct controls on price and/or wage increases; a Pigou tax on price and/or wage increases (TIP); or tradeable inflation permits (MAP). James Tobin was certainly one of the best, and perhaps the best, of the Keynesian money/macroeconomists, and was as "mainstream" as they come. James Tobin stayed a Keynesian, and never became a New Keynesian (or Keynesian In Name Only). We may think it a "heterodox" view now, but it was "mainstream" only yesterday.

David Glasner and James Forder (James kindly emailed me his paper, but there's an ungated earlier version here pdf, thanks to Robert Waldmann) make a convincing case that many economists before Friedman (and Phelps) 1968 knew that expected inflation belonged in the Phillips Curve, and that looser monetary policy could not work once expected inflation caught up with actual inflation. And David and James are serious historians of thought, while I definitely am not (I don't have the brain for it, sadly, so must stick with the simplistic "1968 and all that" version). But sometimes I suspect that historians of thought take so much delight in individual trees that they somehow miss seeing the simplistic forest. All theories are false, including theories of the history of theory itself, but some are useful.

Something must have happened over the last 40 or 50 years to have changed the way economists approach questions like "Does monopoly power cause inflation?". If it wasn't Friedman 1968, because Friedman 1968 was just repeating old stuff that all serious economists already knew, then what was it?

[Update: just an aside for non-economists. It is very tempting to answer my original question "Of course an increase in monopoly power across the economy will cause inflation! If one firm gets an increase in monopoly power it will raise its price, therefore if all firms get an increase in monopoly power all firms will raise their prices!". That's the fallacy of composition. For example, if the central bank targets the dollar price of wheat, then if wheat farmers monopolise and reduce the supply of wheat to raise the price of wheat relative to other prices, the effect will be that the dollar price of wheat stays the same, and other dollar prices will fall.]

Comments

[Market Fiscalist]

So the answer to the question "Does monopoly power cause inflation?" is yes, if the CB is targeting a level of employment higher than the equilibrium rate consistent with that monopoly power ?

Sounds like Friedman came along and reminded people that targeting "full employment" was a bad idea just as the empirical evidence started to indicate the same thing.

[Nick Rowe]

MF: No. Not really. Because if the CB *attempts* to target any level other than the natural rate consistent with monopoly power, it will fail. You cannot say "an x% increase in monopoly power causes a p% increase in equilibrium inflation", because p is undefined.

[Luís Jorge]

Under the natural unemployment rate framework, so long as a central bank is targetting GDP, it is forced to accomodate the inflation that results from the price-wage spiral by expanding the monetary base (tail wagging the dog). The question that comes to mind is: was this describe effectively the Fed's behaviour before and during the 70's?

[Market Fiscalist]

So I get "And if Y* and Y^ are not equal there exists no long run equilibrium inflation rate at all". But start from Y* = Y^ , and then a change in monopoly power decreases y*. The CB could still (in theory) hit Y^ by increasing he money supply sufficiently couldn't it - at least until the side-effects of inflation start to outweigh the expansionary effects of an increased money supply. Why do need to know what the equilibrium rate of inflation is, as long as you know that if the CB increases the money supply sufficiently it will hit the employment target as least in the short-run.

(BTW: Having typed all this in I now see that you say "long run equilibrium" - does that just mean you end up with hyperinflation ?)

[Nick Rowe]

Luis Jorge: good question. I would say that "yes" is the answer that is overly simplistic but more true than false.

MF: under any reasonable assumption about learning and expectations, you end up with ever-increasing inflation and the eventual destruction of the monetary system. People use something else as money, maybe a foreign currency.

[greg]

Let me see: Monopoly: Consumers get less and pay more. With increase in monopoly power labor share
declines. Demand declines. Rent increases. (Monopoly) Production then declines. Increased inequality while economy stalls. Inflation would seem to be indeterminate, or if anything, a deflationary spiral in goods and services, with increasing unemployment is entered. The distribution of the money supply, wealth, becomes increasingly top heavy. As more productive assets are idled, we would expect inflation on those assets which remained in production, or at least in use, both due to their decline in quantity and the increase in (money) wealth among the wealthy. Please check out my blog. Thanks.

[Roger Gomis]

Hi Nick,

"The question just sounds strange to modern economists' ears" definitely describes my first impression about the question. So I have done a quick exercise to try to look it through a modern NK model. I have simulated a NK model - just for practical reasons. In particular I introduce a positive shock to monetary policy; this increases inflation, output and employment. One of the simulations used a low monopoly power the other high monopoly power. Conditional on the monetary shock, the inflation rate obtained is almost ten times higher under the high monopoly power scenario. Of course the difference vanishes in the long run, since by construction all variables return to the steady state. But the difference has a similar persistence than the model in general, for good or bad.

The reason for this is that the price Phillips curve presents a higher slope with respect to the output gap, since an expansive policy produces a positive gap, inflation is higher under the high monopoly power scenario. The reason is not straightforward to put in words -in my case. I follow the equation but not the intuition. But it is something of the following sort: If a firm have to set a price that may last in future periods, and demand is rising so will marginal costs. The firm that has the opportunity to reset the price can respond to future increases in costs, which are proportional in percentage deviation to the output gap. If demand is less responsive to price (high monopoly power, lower CES parameter) the firm will need a higher price to compensate marginal costs than a firm who faces a more responsive demand, because the price increase lowers more rapidly the demand and thus the marginal cost in the latter case.

I could do a similar exercise in a model with both sticky wages and prices (this is in fact the model that I have) and introduce a positive relation between wage and price monopoly power, and try to micro found this. This could potentially create a New Keynesian price wage or wage price spiral - which I'm sure would look really different from the old ones.

I don't know if you find this interesting, I do, but I definitely need to put more thought on the question.

[Derivs]

"just an aside for non-economists. It is very tempting to answer my original question "Of course an increase in monopoly power across the economy will cause inflation! If one firm gets an increase in monopoly power it will raise its price"

If they are young enough they will think of Google, Amazon, Wal-Mart, Home Depot and wonder why you are even suggesting that Monopolies cause prices to increase. Then again wasn't the purpose of Robinson-Patman to stop price discounting? Exactly what France just did with Amazon and book discounting.

Today, product price seems to be determined almost strictly by margins. cost-push or cost-pull.

[Nick Edmonds]

"Would that permanent increase in monopoly power cause a permanent increase in the inflation rate?"

As so often in economics, the answer is that it depends on the framing. If we assume that the monetary authority has an inflation target that is set in stone, then what you say is probably right. They will do whatever it takes to bring the inflation rate back to the target.

But in reality, policy is endogenous. It's quite possible that a temporary increase in the inflation rate may cause the authorities to revise their targets, rather than put the economy through the pain of the adjustment. Do you really believe that current policy is permanent? Or do you believe, as I do, that it will evolve over time in response to circumstances?

The concept of a policy rule set forever is an economists' convenience to make solvable models, but we have to look beyond that to understand what actually happens.

You may say that what has actually caused the increase in inflation is the change of policy, to which I would say "Sure, but what caused the change in policy was the increase in monopoly power ".

But then again, "permanent" has a clear meaning in the context of a model, but less obviously so in discussions about the real world.

[Frances Woolley]

Good post.

[Nick Rowe]

Roger: I do find this interesting. (And I'm pleased to hear you find the question strange, as I suspected, since you're a young guy, right?) It takes my mind back to the 1980's, when I was trying to figure out my own macro model with imperfect competition, and the relationship between degree of monopoly power and strategic complementarity.

Here's my attempt to get the intuition. First, have a quick look my old post of macro with monop comp in pictures.

Start in equilibrium at Y=Y*, then hold all prices constant, and shift the AD curve right, so Y rises to Y'. We move along the MC, D, and MR curves in the second diagram. In the first diagram, the d and mr curves shift right, and the mc curve shifts up. (You can superimpose the two diagrams if you like, so at Y' the d curve cuts the D curve, the mr curve cuts the MR curve, and the mc curve cuts the MC curve, because this is the representative firm.)

The individual firm now wants to raise its relative price p/P. How much? And does the amount vary with the elasticity of demand? Imagine the Calvo fairy lands only on our firm, and on none of the others.

We can ignore the mc and MC curves, since the elasticity of those curves does not depend on elasticity e of the d curve (unless the elasticity of mc and MC varies as we move along those curves).

If we assume CES utility (which is probably what you are doing?) the MR curve is horizontal at (1-1/e). So the slope or elasticity of the MR curve is independent of e.

All the action is in the slope or elasticity of the d and mr curves. As e falls, mr gets steeper, so the individual firm wants to cut y by a smaller amount, but d gets steeper too, so a given cut in y requires a bigger increase in p/P. But the second effect dominates the first. We can see that by taking the limit in the opposite direction, as e approaches infinity (we go towards perfect competition). The tiniest increase in p/P would be enough to create the desired cut in y. So the short run Phillips Curve would be flatter as monopoly power decreases.

Which matches your intuition and your simulations (I think)! Good!

(But we might get different results with a non-CES U function.)

[Nick Rowe]

Roger: my guess is that you have some sort of Taylor Rule in your model, right? Unlike the downward-sloping AD curve in my old pictures post. In which case, the results might depend on how exactly you introduce the AD shock.

In my model, a rightward shift in the AD curve (if that AD curve has a constant elasticity) will cause exactly the same percentage rise in the LR equilibrium price level regardless of the degree of monopoly power. (Though the SR rise will be larger the greater the monopoly power, for reasons discussed above.)

Is it a Taylor Rule? How do you introduce the shock? Because that will affect the results too, quite apart from our intuitions above.

[Nick Rowe]

greg: you are thinking partial equilibrium, so there are fallacies of composition all over the place. Let there be n producers. Each sells his product, and uses his income from sales to buy and consume the products of the other n-1 producers. Start with that thought-experiment.

Derivs: interesting. Amazon etc introduced a new technology, which reduced search costs, and increased competition? So even though it looks like a monopoly the effect was very different?

Nick E: that makes sense to me. But if we model how the monetary authority responds to an increase in monopoly power, and take that into account when we draw the AD curve, we end up with a "deep" AD curve that is once again structural. (Where do we draw the line between shifts and movements along?)

Frances: thanks!

[Nick Rowe]

Roger: Aha! Another thought. Did you actually do this in your simulation?: "(Stick Y^ into the Taylor Rule, instead of potential output Y*, with a really big coefficient in front of Y-Y^, and a coefficient of zero in front of the deviation of inflation from target, because there isn't an inflation target.)" And then introduced a shock to Y^ ?

Because then I think I know what's going on in your simulation. Do you have the discount factor B=0.99 and < 1.0 in your Calvo Phillips Curve? Because that gives a LR PC that is not precisely vertical.

You now have an NK model which mimics an OK model!

[Nick Edmonds]

As a further thought, is it not possible that an increase in monopoly power might lead to a permanent reduction in the growth rate of real GDP, such that if the monetary authority is targeting the path of NGDP, this will imply permanently higher inflation. It depends on what you believe on the exogeneity or otherwise of long run growth of course.

[Nick Rowe]

Nick E: Yep. But the effect of monopoly power on LR growth could go either way.

Basically, since everything depends on (almost) everything else, (almost) anything can affect inflation.

*But you can't talk about how X affects inflation without talking about money and monetary policy.* The old guys wanted to talk about "cost push" inflation, which didn't depend on monetary policy, vs "demand pull", which did. A distinction with no meaning, that just confused the hell out of everything.

[Nick Edmonds]

Yes, I find the distinction unhelpful. I don't think you can understand inflation without thinking about cost push pressures. But you also can't say anything about how things pan out without asking how policy responds.

[Nick Rowe]

Nick E:

The "monetary fundamentalist" (not necessarily the same as "monetarist") in me wants to reply: "But inflation IS a falling value of MONEY, so money MUST be centre stage!"

And the policy guy in me wants to reply: "But policy can be anything we choose it to be, whereas the rest of the economy is what it is, so monetary policy can prevent or undo the effects on inflation of any other changes if we want it to, so monetary policy MUST be centre stage!"

[Majromax]

I think that this topic may be related to the question of why deflation is bad.

In the simplest models, we're as content with a -2% inflation target as a +2% inflation target. This falls apart in reality, where workers and businesses react poorly to nominal decreases in wages. In effect, even non-monopoly workers act like they have price-setting power when facing a nominal wage cut.

Translate this to a highly-unionized environment with inflation expectations. Here, unions that exhibit wage-setting power will uniformly build cost-of-living adjustments into their wage contracts, such that 0% real wage growth is the new 0% nominal wage growth.

Our Calvo fairy behaves strangely: a subset of workers get to freely set their prices, but then all remaining workers have wages increase at the average of that subset, as a cost-of-living adjustment.

Ultimately, this decreases the efficiency of the economy, by making it more difficult for relative wages to adjust. (I.e., the monetary economy looks less like a magic barter economy)

[Roger Gomis]

Hi Nick,

I'm fairly young, still a PhD student (I think now we are called young adults, or something like similar). "the individual firm wants to cut y by a smaller amount, but d gets steeper too, so a given cut in y requires a bigger increase in p/P. But the second effect dominates the first" That's exactly right; looking at the equation I was unable to distinguish the opposite effects.

Regarding the simulation, "you have some sort of Taylor Rule in your model, right?" right, I have nom = RHO + PHI_PI * pi_p + PHI_Y * y_tilde - v , nom is the nominal interest rate, RHO is the natural rate in log terms -log(Beta=0.99), PHI_P the taylor coefficient on inflation(pi_p), PHI_Y, the taylor coefficient on output gap(y_tilde), 1.5 and 0.25 which are pretty standard. Finally v is how I introduce the monetary policy shock, v is an AR(1) process and at the beginning of the simulation it suffers a positive shock. So basically the MP is laxer than usual and the real rate is lower than in steady state. I do the simulation for CES very high and very low. The price Phillips curve is pi_p = BETA * pi_p(+1) + KAPPA_P * y_tilde + LAMDA_P * w_tilde; with pi_p being price inflation, BETA=0.99 discount, y_tilde output gap, w_tilde wage gap (with respect to the natural wage as well) with high monopoly power LAMDA_P=0.05, and KAPPA_P =0.02, with low monopoly power LAMDA_P=0.001 and KAPPA_P=0.0004. All natural rates of output and wages remain constant since technology is constant. The model is the sticky prices and wages model of Galí's book (you have commented on it sometimes) of chapter 6. Regarding the simulation of introducing the large coefficient on (Y-Y^), I cannot do exactly the same, since the program log linearizes around the steady state, so all level information is irrelevant. However I can do a modification to the Taylor rule, which now is like nom = RHO + 80 * (y_t - v) where v is the MP shock, which now can be understood as a temporary higher target for output, above the steady state level, similar results are obtained.

The exercise that would answer the strange question would be to introduce variable markups in the model. The simulation just does "dynamic comparatives" and does not address a shock to markup. I will think about it but I think it will require some hard work.

[greg]

If as you assert *everybody,* including labor, has monopoly power, then yes, you *might* get inflation. You might not, but it would seem that any particular degree of inflation, including zero, or even negative, would be a neutral equilibrium. It would maybe depend on animal spirits. Assuming equal power, equal 'competitiveness,' you would not expect the distribution of income and demand to change. Hmm. But the velocity of money might increase, rel the velocity of goods, which would seem to imply a positive inflation... Producer surplus increases, consumer surplus decreases. But, given everybody's a monopolist, can they, really? A change in one seems to imply an identical change in the other. Or even only nominally? (I can see everybody thinking this out, and anticipating future increases by everyone else, concluding they should charge an infinite amount!)

However, while the circle of monopolists might be in some sort of such equilibrium, anyone outside the circle must still pay more for less. The distribution of income across the circle, and thus the distribution of demand across the circle, will change. The monopolists will gain, the rest lose. Those markets, those producers, which lose income will lose demand and contract. When those producers are labor, as is most likely since they are naturally the least concentrated, that market, the market for final goods and services, will contract. This situation is unstable. While due to borrowing, this decline need not be monotonic, borrowing will not change the stability characteristics. Asset inflation, goods and services deflation, although the latter would depend on whether or not production, as likely, declined slower than labor's ability to consume. With increasing capitalization and productivity, this would be expected.

[Lou]

Why going back to the 70s?
Evidence is mounting that, in recent years, the US economy is becoming less competitive - that is, monopoly power is on the rise. There's a whole literature on US businesses getting older, various non-systematic bits of evidence coming from individual business sectors, etc.
Yet inflationary pressures have been fairly soft throughout.
What would you make of this? Where does the "ceteris paribus" fail? Globalization, China, and so on?

[Nick Rowe]

Roger: OK. That's a very standard Taylor Rule, with an AR(1) shock added. So all the action is coming from the steepening of the SR PC, just as in our original intuitions.

Are those current or lagged output gaps and inflation gaps in your Taylor Rule? If they are lagged, I could see how the steeper SR PC with lower e gets "multiplied" up by the real interest rate going down by more when actual and expected inflation go up by more, with the steeping of the SR PC. (If that makes sense.)

I think it makes sense that KAPPA_P and LAMBDA_P should get bigger, as e falls, for the reasons we discussed above.

Do your firms have a production function with diminishing Marginal Product of Labour? Because otherwise Marginal Cost should be a function of W only, and I would have expected KAPPA_P to be zero in a CES model.

[Too Much Fed]

"For example, if the central bank targets the dollar price of wheat, then if wheat farmers monopolise and reduce the supply of wheat to raise the price of wheat relative to other prices, the effect will be that the dollar price of wheat stays the same, and other dollar prices will fall.]"

1) How would the central bank enforce the dollar price of wheat target?

2) If farmers reduce the supply of wheat, will employment go down?

[Nick Rowe]

Majro: it is not obvious to me why prices (or wages) set by a monopolist should respond less to shocks (aside from the small menu cost argument), nor obvious why they should be less subject to money illusion.

greg: this is very muddled:

"The monopolists will gain, the rest lose."

That's not obvious. It is quite possible that the monopolists will lose too. What is in the interest of each monopolist will not be in the interest of all monopolists. Fallacies of composition.

"Those markets, those producers, which lose income will lose demand and contract."

And those which gain income will gain demand and expand? Why isn't it a wash in aggregate?

Stop, and think. Start with a symmetric model. It is easier to spot fallacies of composition in that case.

Lou: I would have guessed, that with freer trade, and lower transport cost per value, competition would have increased over the years. But that's just a guess.

[Roger Gomis]

Hi Nick,

There is indeed diminishing returns to labour, and yes, if there are constant returns KAPA_P will be zero. The SR PC is a standard forward looking one, so inflation gap on the LHS and ouput gap in the RHS are present period, inflation on the RHS is next period. I would say that with your intuitive version the model sort of make sense.

[greg]

Nick quoting me:“"The monopolists will gain, the rest lose."”
Nick:“That's not obvious. It is quite possible that the monopolists will lose too. What is in the interest of each monopolist will not be in the interest of all monopolists. Fallacies of composition.”

The monopolists lose, too. Indeed, they pursue policies destructive to the entire economy. I apologize for not getting to the ultimate conclusion to my argument in my previous comment.

My thought is that where the monopolists do business with each other, that is, where their interests conflict, these effects will cancel out. This might not be true. There might be inflation. There might not. But I do not think this is as important as the distribution of income in the economy, the distribution of income between the monopolists and the rest of the economy. Indeed, inflation itself is a wash, where it affects all sectors equally. It is the differences in the rates of inflation between the various sectors of the economy that affect the distribution of income.
So suppose these effects cancel out. Then it is only where the monopolists deal with the rest of the economy that there will be a net effect. It’s as if the rest of the economy has to deal with one big monopoly. If that one big monopoly is relatively small to the rest of the economy, that monopoly can operate effectively as a monopoly, maximizing profits, restricting production, etc. And the rest of the economy can also operate OK despite that. Relatively small would mean that the monopoly’s actions did not significantly affect the size of its market. If the one big monopoly is relatively large to the rest of the economy, its actions will affect the size of its market. So consider that model. We will observe a fallacy of composition.

If the relatively large to the rest of the economy big monopoly seeks to maximize profit in the short term, (all monopolists acting in their own interests,) it will change the distribution of income in the economy: Its income will increase, while the income of its customers will decrease. Can this happen? Yes, we’re seeing it happen, with the increasing share of capital income and decreasing share of labor income in the United States. But is this due to monopolistic power? It seems one reasonable explanation. So let’s look at this.

Nick quoting me:“"Those markets, those producers, which lose income will lose demand and contract."”
Nick:“And those which gain income will gain demand and expand? Why isn't it a wash in aggregate?”

The big monopoly gains income. It becomes awash in cash, and high paid CEO's. (It doesn’t invest, or produce more productive assets, because big monopoly would be competing against itself. It does produce an excess of non-productive assets, though, like yachts, mansions, etc. The increase in non-productive assets does not increase as fast as the cash, though. The wealthy do save more.) So the price of assets is driven up. Inflated. Meanwhile, the income of its customers in the rest of the economy does not change, but their expenses increase. While trying to maintain consumption, they first divest themselves of assets to big monopoly and then, eventually, become awash in debt. Even while trying to maintain consumption, the consumers fail and fall behind being able to keep up with what big monopoly produces. While initially there may be inflation, there follows deflationary pressure as big monopoly’s production outstrips the consumption of these goods by the consumers. Price reductions ensue. Big monopoly cuts back production, seeking to maintain its (high) profit margins. It lays off labor, and since big monopoly is relatively large, the labor it lays off is a significant portion of its market. And so the economy enters a contraction: reduced demand begets reduced production begets layoffs begets reduced demand, etc. (Except, of course, for non-productive assets.)

A couple of problems with the big monopoly model are addressed if we relax our model to monopolistic competition. This would impose strong limits on the ability of big monopoly to raise prices and restrict production. In this case also, we would expect the cut backs in production to be manifested by shut downs of lower margined and more poorly positioned firms. We would still expect an excess of cash and reduced investment, because of the higher costs of entering the markets of other monopolistic competitors, and thus lower expected returns. And new markets seem to be limited, probably by the limits in consumer demand already imposed.

The ultimate conclusion seems to be economic collapse, as the monopolists end up with all the money, all the assets, and no market for their goods, having economically disenfranchised the populace. Who may come to resent what was done to them. (Libertarians, though, will cry out that it was just, and that the people have no cause for complaint.) And since they will have also destroyed the tax base, which relies on flow and not stock, this may present them a problem. Libertarian paradise, indeed.

Thanks, Nick, for helping me put this together.

[Majromax]

@Nick Rowe:

> Majro: it is not obvious to me why prices (or wages) set by a monopolist should respond less to shocks (aside from the small menu cost argument), nor obvious why they should be less subject to money illusion.

I thought it was relatively standard practice at the time for union contracts to include automatic cost-of-living adjustments? That would seem to be definitive of not being subject to money illusion.

[Jacques René Giguère]

greg: this seems like an article I saw in American Scientist, years back. I'll try to find it but I am on the raod for a few days so maybe no result.

[Frank Restly]

Nick,

"Suppose there is a permanent increase in monopoly power across the economy (either firms having more monopoly power in output markets, or unions having more monopoly power in labour markets). Would that permanent increase in monopoly power cause a permanent increase in the inflation rate?"

How does the elasticity curve of the good being supplied (labor / output) compare to the elasticity curve of the medium of exchange? Does a profit maximizing firm without competition gain from producing fewer goods and selling them at a higher per unit cost?

[Nick Rowe]

greg: please do not thank me for putting that together. Sorry, but it's just a mare's nest of confusions. I'm not to blame for it.

Jacques Rene: has Scientific American got that bad?

Frank: is there any reason at all you are asking that question? (That was a rhetorical question; don't reply.)

[Felipe]

50 years ago would be 1965. At that time, the US (and the whole world) was under a gold standard.
If monopoly power is increased, the scarcity of goods vs gold would increase, thus decreasing the relative price of gold => prices in terms of gold go up => inflation.

Under inflation targeting, things change, as you note. But may it be true if under a gold standard?

[Nick Rowe]

Felipe; good question. good point. It all depends on the monetary policy regime, and a gold standard is very different.

[greg]

Well, thanks for your time and space, Nick.

[Jacques René Giguère]

Nick: don't confuse American Scientist,
http://www.americanscientist.org/
the journal of the Sigma Xi Society with Scientific American, a shadow of its former self.
The article was a modelization of how increasing inequality leads to markets crashing due to lack of distributed purchasing power. Somewhat analogous to a predator so efficeitn it kill all its prey then die of hunger.

[greg]

Thanks Jacques, and you might want to check out the recent 'Human and Nature Dynamics(HANDY} model:' http://www.sciencedirect.com/science/article/pii/S0921800914000615 ,that made the press in March of this year.

The Press on it is interesting also. The model has political implications, (emotional ones, too,) which is why I think it was effectively quashed by the 'Media that Be.' It doesn't get into the symptomology, which is what I think we are seeing first hand.

[Jacques René Giguère]

greg:I like AMScientist. In the days before blogs, when letters to the editors were screened and few were published, I had one there showing the analogy and similarity between the equilibrium in the electric grid and the way airlines send you through weird connections (for once, my dual nature physicist-economist being useful.)

[greg]

Hi Jacques. Don't know how to talk to you except here. Did check out your activity. So please comment to my blog. Thanks. Do want to know if you find that article.

[Jacques René Giguère]

greg: busy schedule. I'll try.