Market Polarization and the Phillips Curve

Abstract

The Phillips curve has flattened out over the last decades. We develop a model that rationalizes this phenomenon as a result of the observed increase in polarization in many industries, a process along which a few top firms gain an increasing share of their industry market. In the model, firms compete à la Bertrand and there is exit and endogenous market entry, as well as optimal up and downgrading of technology. Firms with larger market shares find optimal to dampen the response of their price changes, thus cushioning the shocks to their marginal costs through endogenous countercyclical markups. Thus, regardless of its causes (technology, competition, barriers to entry, etc.), the recent increase in polarization in many industries emerges in the model as the key factor in explaining the muted responses of inflation to movements in the output gap witnessed recently.