Monopoly and the Banker: More Than a Board Game
Australian Conference of Economists, Brisbane
Wednesday, 12 July 2023
Since our panel has been asked to riff off Governor Lowe’s remarks in his lunchtime talk, I thought it would be helpful for me to focus on the ways in which developments in my portfolio of competition have affected monetary policy.
The job of the Reserve Bank is never easy, but it is especially challenging at times when inflation is outside the target band. Russia's illegal invasion of Ukraine and major problems with vital supply chains are undoubtably key drivers of Australia's inflation problem.
Nonetheless, two new pieces of research suggesting that a lack of competition may impede the transmission of monetary policy – effectively making life harder for central bankers. Both were published in May in the American Economic Review Papers and Proceedings.
The first study, by Romain Duval, Davide Furceri, Raphael Lee and Marina M. Tavares, considers the effect of markups. Markups are the gap between cost and price. In a highly competitive market, markups tend to be small. When monopolies rule, markups are massive. Across many advanced countries, markups have risen over recent decades.
As the authors point out, there are various reasons why high-markup companies are likely to be less responsive to monetary policy. They may be less credit-constrained. Their investment decisions may be less subject to changes in financing conditions.
The authors then take their theory to the data. Using data across fourteen advanced economies, they find that monetary policy is indeed less effective in shaping the decisions of high-markup firms, particularly when those firms are older. Fat markups mean that companies are less likely to change their behaviour in response to monetary policy. One way to think about this result is that high-markup firms don’t do the work of responding to central bank decisions. The other implication is that when markups are large, firms in general won’t be very responsive to monetary policy – leaving the work to households.
Markups are the result of firms’ power in the product market. But as Joan Robinson taught us, firms can also have power in the labour market. A monopoly overcharges its customers. A monopsony underpays its workers. And just as firms’ product market power has been rising, so too the degree of labour market power has been increasing.
The second study, from Anastasia Burya, Rui Mano, Yannick Timmer and Anke Weber, looks at the implications of monopsony power for monetary policy. If firms face little competition for employees, how does this affect the way the economy responds to monetary policy?
Using data on online job postings from across the United States, they find that in places where firms have a lot of labour market power, they can hire workers without having to raise wages as much. Usually, a lot of hiring means better wages. But when there isn’t much competition between employers, this weakens the relationship between employment and changes in wages. The result is a flatter wage Phillips curve.
This matters because the Phillips Curve reflects one of the ways that a tight economy has typically delivered for workers and households. A normal Phillips Curve relationship means that when unemployment is low, firms need to start raising wages to attract workers. But that ceases to be true in a world of high market power. The authors of the second study find that in places where market power is high, there is no relationship between wage growth and the unemployment rate.
This matters for monetary policy. If monetary authorities seek to reduce price pressures, they will have a tougher time of it when monopsony rules. In that environment, unemployment needs to rise more to achieve a reduction in inflation. As they put it, ‘labour market power increases the sacrifice ratio between inflation and unemployment’.
The other implication is distributional. Because places where labour market power is strongest tend to be poorer, the pain of rising interest rates ends up being felt most acutely where incomes are lowest, exacerbating income inequality.
What do these studies mean for Australia? Over recent decades, Australia has seen a rise in market concentration and markups, and an increase in monopsony power. Our biggest firms have more power to push prices up, and to keep wages down.
There are many reasons this matters, but an important one is because it weakens the transmission of monetary policy. Companies with high markups are less likely to respond to interest rate changes, putting the burden on to young, low markup firms. Companies with high labour market power are less likely to respond to tight labour markets by raising wages. This creates a risk that when central banks want to get inflation under control, they end up pushing unemployment higher than they would if there was plenty of healthy competition between employers.
Insiders often argue that Australia doesn’t have a competition problem – that an economy dominated by a few big firms is just a fact of life downunder. But these new studies point to another powerful reason why we should worry. It is in the national interest for monetary policy to be effective. If a lack of competition makes monetary policy less effective, then this can have both efficiency and equity costs – impeding growth and harming fairness. If you care about central banks being able to do their jobs, then you should care about a competitive and dynamic economy.