Battle of the markups: conflict inflation and the aspirational channel of monetary policy transmission

Since the post-Covid rise in inflation has been accompanied by strong wage growth, the distributional conflict between wage- and price-setters (both wishing to attain a certain markup) has regained prominence. We examine how a central bank should resolve a “battle of the markups” when aspired markups are cyclically sensitive, highlighting a new “aspirational channel” of monetary transmission. We establish conditions under which an inflationary situation characterized by inconsistent aspirations requires a reduction in economic activity, to eliminate worker-firm disagreement over the appropriate level of the real wage. We find that countercyclical markups and/or a flat Phillips curve call for more dovish monetary policy. Estimating price markup cyclicality across 61 countries, we find evidence for countercyclicality in most of them