Markups and the asymmetric pass-through of cost push shocks

Summary

Focus

Many countries have witnessed a significant increase in corporate pricing power in recent decades. Against this background and following the post-Covid surge in inflation, there was hope that high markups could absorb some of the cost pressures. However, high markups could also contribute to inflation. Firms with a high degree of market power may find it easier to pass on cost increases to their customers. Likewise, firms charging high markups could retain some of the benefits of falling input costs.

Contribution

In this paper, we focus on global oil supply shocks and address this debate in two ways. Using sectoral data for the United States, we first investigate if the pass-through of global oil supply shocks is lower in sectors where firms charge higher markups. Second, we take the analysis to the firm-level. We investigate how markups and sales respond to global oil supply shocks.

Findings

We first document that the pass-through of oil shocks is weaker in sectors where firms charge higher markups. However, high markups essentially reduce the pass-through of disinflationary oil shocks, ie shocks that cut the price of energy. Conversely, markups make scarcely any difference to the pass-through of inflationary oil shocks, ie shocks that raise the price of energy. Second firms charging high markups are significantly more likely to raise their markups and increase their revenues, following disinflationary oil shocks. By contrast, the response of high- and low-markup firms to inflationary oil shocks is broadly similar. Altogether, these results suggest that high-markup firms draw significant benefits from disinflationary oil shocks. They also suggest that high markups provide little cushion against inflationary oil shocks.

Abstract

This paper studies how prices and markups respond to cost push shocks, taking the example of global oil supply shocks. Using sector-level data for the US, we first document a weaker pass-through of global oil shocks to PPI inflation in sectors where firms charge higher markups. However, high markups mainly reduce the pass-through of dis-inflationary oil shocks, while they barely affect that of inflationary oil shocks. Second, using firm-level data, we show that following a dis-inflationary oil shock, high-markup firms are more likely to raise their markup. In addition, they are also more likely to increase their revenues, and hence their profits. Conversely, we find no difference in the response of high- and low-markup firms to inflationary oil shocks. Taken together, these results suggest that high-markup firms draw significant benefits from dis-inflationary oil shocks, as they are able to raise their markups and expand their revenues. They also suggest that high markups provide little cushion against prices pressures stemming from inflationary oil shocks.

JEL classification: R3, G51, I31

Keywords: housing affordability, real estate markets